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/ 86.45.131.* / 2009-11-25 22:08
Option ARMs: Housing recovery killer?
An explosion of foreclosures will result from option ARMs set to reset to higher payments
NEW YORK (CNNMoney.com) -- Option-ARMs: File under, "It sounded good at the time."
These exotic mortgages allowed homebuyers to come to closing with little cash and choose, monthly, how much to pay: interest and principal, interest only, or a minimum amount less than the interest due
Nearly all of the 350,000 option-ARM borrowers owe more than when they first bought their homes thanks to unpaid interest accumulating. And many loans written during the first big wave, which started in 2004, are getting ready for their five-year reset, when they become standard, amortizing loans. Additionally, some newer loans, where accumulated interest has pushed the loan-to-value ratio above 110% to 125%, will also reset.
That means borrowers are about to start paying very hefty prices for their homes. In one scenario outlined in the S&P report, the payment on a $400,000 mortgage jumps from $1,287 to $2,593.
25% default rate
But that doesn't just spell bad news for borrowers. Some industry pessimists say the looming default problem could have the power to derail the nascent housing market recovery. "The crux of the matter is that as soon as these mortgages recast, the history is that they will default," said Brian Grow, one of the S&P report's coauthors.
And the newer the loans, the worse they will perform, the report said. The last year that any option-ARMs were issued was 2007. In the first 20 months after issuance, this vintage of option-ARMs had an average default rate of just over 22%.
That includes all option-ARMs issued in 2007. But if you calculate default rates for only 2007 option-ARM borrowers who are now underwater, the default rate jumps to 25% after just 20 months, according to S&P.
So, while there may not be an awful lot of these loans out there, their high default rates will have an outsized influence on housing markets, adding to already bloated foreclosure inventories and driving prices down further