There's A New ARM Load of Trouble on the Housing Horizon
Tuesday, May 26, 2009JEFF YASTINE: The housing market may still have some room to fall before hitting bottom. That's according to a closely watched report released today. The S&P Case Shiller home price index found a 19 percent drop in single family home prices during the first quarter this year. Compared to the same period last year, it's the largest quarterly decline in the report's 21 year history. Prices in 20 major metropolitan areas also dropped nearly 19 percent in March, raising new doubts about a turnaround for the housing industry.
SUSIE GHARIB: Tumbling home prices continue to impact thousands of home loans made between 2004 and 2007. Especially hard hit, payment option adjustable rate mortgages or the so-called option ARMs. While those loans were made to borrowers with good credit scores, they're rated just above sub-prime mortgages. And as Stephanie Dhue reports, option arms are on track to cause a whole lot of trouble.
STEPHANIE DHUE, NIGHTLY BUSINESS REPORT CORRESPONDENT: When the housing market was booming, more than a million borrowers chose loans that required no money down and gave them the option to make minimum payments. All the while, their principal balances continued to grow, known as negative amortization. Financial consultant Ed Pinto calls these loans poison.
EDWARD PINTO, FINANCIAL SERVICES CONSULTING: They are extremely toxic. In the last 15 or 16 months, the default level on (INAUDIBLE) ARMs has increased from about 15 percent to I estimate 35 percent, which is a huge increase in a very short period of time.
DHUE: Heavily concentrated in states where home prices have plunged like California, Florida and Arizona, when these loans go bad, they go really bad. Lender losses in many cases top 50 percent. Pay option loans were a major factor in the failure of banks like Indymac, Wachovia, and most recently Florida's Bank United. These loans are on track to wreak more havoc in the next two years as they reset. When that happens, the borrower must begin making payments toward principal. Estimates are as many as 85 percent of borrowers with these loans make only the minimum payment. In that case, the principal is then added to the amount of the loan. Realtytrac's Rick Sharga says it can be an ugly scene.
RICK SHARGA, V.P. MARKETING, REALTYTRAC: Here's the scenario, when they reset the homeowner will be at least 15 to 20 percent upside down on their loan, but it's actually worse than that, because that's the paper value of the home. It doesn't take into account depreciation over the last couple of years, so more likely you're going to be 30 to 40 percent upside down on your loan. Your loan payment will have increased by $1,000 to $1,500 a month, depending on the size of your loan.
DHUE: There are still more than 3/4 of a million of these loans outstanding worth more than $300 billion. Pinto says their potential for damage depends a lot on interest rates.
PINTO: The $64,000 question is going to be what are interest rates going to be two years from now, because those resets are a year to two years down the road and today interest rates are very low. Normally that would be helping this problem, but clearly again with a 35 percent default rate, it isn't doing much.
DHUE: Loan modification isn't doing much to help either.
SHARGA: The Obama administration's foreclosure prevention programs, while they are by far the best we've seen so far, don't really address severely upside down loans, because it still would require the lender to take a significant hit on capital, principal balance.
DHUE: The combination of toxic loans, falling home prices and rising unemployment create a recipe for foreclosures to remain high for at least the next two years. Stephanie Dhue, NIGHTLY BUSINESS REPORT, Washington.
