Sonoma Housing Bubble

Pulling the cork out of Sonoma's bubbly housing foolishness

Wednesday, September 06, 2006

More than 1/5th 2004 & 2005 ARMS are UnderWater

"The option adjustable rate mortgage (ARM) might be the riskiest and most complicated home loan product ever created. With its temptingly low minimum payments, the option ARM brought a whole new group of buyers into the housing market, extending the boom longer than it could have otherwise lasted, especially in the hottest markets."

"Suddenly, almost anyone could afford a home -- or so they thought. The option ARM's low payments are only temporary. And the less a borrower chooses to pay now, the more is tacked onto the balance."

"For cash-strapped homeowners, it was a pitch they couldn't refuse: Refinance your mortgage at a bargain rate and cut your payments in half. New home buyers, stretching to afford something in a super-heated market, didn't even need to produce documentation, much less a downpayment."

"The option ARM is "like the neutron bomb," says George McCarthy, a housing economist at New York's Ford Foundation. "It's going to kill all the people but leave the houses standing."'

"Those who took the bait are in for a nasty surprise. While many Americans have started to worry about falling home prices, borrowers who jumped into so-called option ARM loans have another, more urgent problem: payments that are about to skyrocket."

"The bill is coming due. Many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules -- often to the astonishment of people who thought the low installments were fixed for at least five years. And because home prices have leveled off, borrowers can't count on rising equity to bail them out."

"What's more, steep penalties prevent them from refinancing. The most diligent home buyers asked enough questions to know that option ARMs can be fraught with risk. But others, caught up in real estate mania, ignored or failed to appreciate the risk."

"There was plenty more going on behind the scenes they didn't know about:

* that their broker was paid more to sell option ARMs than other mortgages;

* that their lender is allowed to claim the full monthly payment as revenue on its books even when borrowers choose to pay much less;

* that the loan's interest rates and up-front fees might not have been set by their bank but rather by a hedge fund;

* and that they'll soon be confronted with the choice of coughing up higher payments or coughing up their home."

"After prolonging the boom, these exotic mortgages could worsen the bust. They also betray such a lack of due diligence on the part of lenders and borrowers that it raises questions of what other problems may be lurking. And most of the pain will be borne by ordinary people, not the lenders, brokers, or financiers who created the problem."

"So how did these unusual loans get into the hands of so many ordinary folks? The sequence of events was orderly and even rational, at least within a flawed system. In the early years of the housing boom, falling interest rates made safe fixed-rate loans attractive to borrowers."

"As home prices soared, banks pushed adjustable-rate loans with lower initial payments. When those got too pricey, banks hawked loans that required only interest payments for the first few years. And then they flogged option ARMs -- not as financial-planning tools for the wealthy but as affordability tools for the masses."

"Banks tapped an army of unregulated mortgage brokers to do what needed to be done to keep the money flowing, even if it meant putting dangerous loans in the hands of people who couldn't handle or didn't understand the risk. And Wall Street greased the skids by taking on much of the new risk banks were creating."

"Now the signs of excess are crystal clear. Up to 80% of all option ARM borrowers make only the minimum payment each month, according to Fitch Ratings. The rest of the money gets added to the balance of the mortgage, a situation known as negative amortization. And once balances grow to a certain amount, the loans automatically reset at far higher payments. Most of these borrowers aren't paying down their loans; they're underpaying them up."

"To get the deals done, banks have turned increasingly to unregulated mortgage brokers, who now account for 80% of all mortgage originations, double what it was 10 years ago, according to the National Association of Mortgage Brokers."

"In 2004 banks began offering fatter sales commissions on option ARMs to encourage brokers to push them, says Gail McKenzie, assistant U.S. attorney in Atlanta, who is investigating mortgage brokers for improper practices."

"The problem, of course, is that many brokers care more about commissions than customers. They use aggressive sales tactics, harping on the minimum payment on an option ARM and neglecting to mention the future implications. Some even imply verbally that temporary teaser rates of 1% to 2% are permanent, even though the fine print says otherwise. It's easy to confuse borrowers with option ARM numbers."

"A recent Federal Reserve study showed that one in four homeowners is mystified by basic adjustable-rate loans. Add multiple payment options into the mix, and the mortgage game can be utterly baffling."

"Then there's the illegal stuff. Mortgage fraud is one of the fastest-growing white-collar crimes in the nation, costing $1 billion in 2005, double the year before. A slower housing market could foster more wrongdoing. "With a tighter market, you are going to find there is more incentive to manipulate," says Tim Irvin of Irvin Investigations & Research Services in Spring, Texas. "Brokers are having a harder time getting business, so they're getting creative."'

"Most of the pain will be born by ordinary people. And it's already happening. More than a fifth of option ARM loans in 2004 and 2005 are upside down -- meaning borrowers' homes are worth less than their debt. If home prices fall 10%, that number would double."

'"The number of houses for sale is tripling in some markets, so people are not going to get out of their debt," says the Ford Foundation's McCarthy. "A lot are going to walk."'


At 9/06/2006 10:43:00 PM , Anonymous trailer trash said...

"More than a fifth of option ARM loans in 2004 and 2005 are upside down -- meaning borrowers' homes are worth less than their debt. If home prices fall 10%, that number would double."

"The number of houses for sale is tripling in some markets, so people are not going to get out of their debt ... A lot are going to walk."

We all knew that the real estate bubble was unsustainable. We all knew the day would come when the bubble would eventually deflate. Now that this end is in sight, we can only hope for the best.

The collapse of the real estate market will be a great tragedy. We will all be affected by the upcoming economic disaster caused by the collapse of the biggest real estate pyramid scheme of all time.

This is uncharted territory. How political and social changes will play out is anyone's guess. One thing is sure -- it won't be pretty.

At 9/06/2006 10:56:00 PM , Blogger Athena said...

Everyone knew it would come to an end except those who believe themselves when they say it always goes up, and you can't lose, and get in or get priced out.

recessions always offer investment opportunities. the coming real estate recession will be no exception. The key is to keep your eyes open, and your money liquid.

At 9/07/2006 12:45:00 PM , Anonymous tom stone said...

Mortgage brokers in california are regulated,and so are real estate brokers.without enforcement those regulations mean far as making more on an opion arm,mortgage brokers can choose a rebate of (usually) 1 to 3%,paid by the lender.the higher the rebate,the higher the interest rate.although the borrower is actually paying the fee the disclosure is on another line of the contract,and is sometimes quickly glossed over "man, i got you a deal,no points!" if the kind of licensing requirements and enforcement that hairdressers are subject to were applied to the real estate field it would be a much cleaner i'm not kidding,check out the requirements.

At 9/08/2006 04:06:00 PM , Blogger marin_explorer said...

"Now that this end is in sight, we can only hope for the best."

LOL. Remember that movie, Alien, where that chest-bursting creature rampages through the spaceship, destroying everyone?

It's sort of like that final sendoff from that smirking, dying conspirator:

"I can't lie to you about your chances, but... you have my sympathies."

Guess I like movie quotes, eh?

At 9/10/2006 03:25:00 PM , Blogger Housing Boom Gone Bust said...

Yes, those ARMs are a big part of all of this and the remedy will be painful..


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