Housing Defaults Take a New Turn

There’s news today of a new turn in the housing defaults mess. The L.A. Times reports, If you “thought the mortgage meltdown was just a sub-prime affair”… “Think again.”

There’s another time bomb waiting to explode, experts say: risky loans made to people with good credit.

So-called pay-option adjustable-rate mortgages, or option ARMs, were the easiest and most profitable home loans for lenders and brokers to make for much of this decade. Last year, they accounted for about 9% of the volume of all mortgages made in the U.S. and were especially popular in California, Florida and Nevada — states where home prices rose the most during the housing boom and are now falling most sharply.

The L.A. Times explains, “an option ARM loan gives a borrower the option of paying less than the interest due, causing the loan balance to rise.”

If it rises too much — say, by 10% or 15% — the opportunity to make a low payment vanishes and the required payment skyrockets.

That scenario is becoming increasingly common. In fact, more than 75% of option ARM borrowers have been making only the minimum payments, analysts at Standard & Poor’s Corp. said last week. As a result, the delinquency rate on option ARMs already is jumping and is likely to keep rising sharply, S&P said.

Adding insult to injury for homeowners in a mess, the L.A. Times reports, that “because option ARMS went only to “prime” borrowers, they aren’t eligible for a much-publicized interest rate freeze that is part of a White House-backed plan to stem sub-prime foreclosures,” and they predict we’ll be seeing foreclosures “growing more common in affluent neighborhoods.”

Whether it’s a wealthy community or a sub-prime community, it all comes down to how much equity the borrower has and how much home prices fall,” said Joshua Rosner, a managing director at investment research firm Graham Fisher & Co.

Option ARMs were originally offered in the 1980s by California savings and loans as a way to give some financial flexibility to self-employed people and others with variable incomes. But as homes became more expensive this decade, they became increasingly desirable simply because of the ability to make extraordinarily low payments for a good period of time.

Taking a look at the housing market crisis, Paul Krugman asks today, “Housing: How far is down?” Krugman contends that “the price-rental ratio will have to move most if not all the way back to historical norms. And that’s a long, long way down.”

A long way down indeed. Frankly, as renter, I would welcome a drop in rents. Here in L.A., like many places, rents are astronomical and after 15 years in a rent controled building, moving simply isn’t an option.

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2 Responses to Housing Defaults Take a New Turn

  1. Pingback: Grim Way To End The Year « The Krile Files

  2. Darrell Prows says:

    One thing that Option Arms did was move some defaults/foreclosures into the future. Some people asking for them needed to get their monthly budget back under control or would have lost their homes then and there. Likely some used this restructuring of their budget successfully, and some only managed to postpone the inevitable. As part of the perfect storm hitting housing and the economy this approach will add more foreclosure homes to the market at the worst possible time, rather than having worked through them gradually over the course of the last couple of years.