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He wonders what will happen to people who got low-rate
ARMs when the rates enter the adjustment period and rise dramatically. "I
think people have no idea what can happen when the loans reset at higher rates,"
he says. "People say, 'Oh, I'll refinance in the future.' But we've been
at 30-year- and 40-year-low interest rates!"
That brings us back to Cagan, who wrote the paper for First American
about reset sensitivity -- what will happen
when borrowers' payments spike after ARMs hit their adjustment periods?
He says there will be an extraordinarily high default rate among
people who got teaser-rate option ARMs and who have less than 15
percent equity in their homes. But those people are a small part
of the overall pool of homeowners.
"Nationally, I think it will be a common cold, if you will," Cagan says,
while acknowledging that it will feel much worse to the people who lose their
homes to foreclosure.
"The people who bought in
2003 or sooner ... they generally have enough
equity that they're going to do all right,"
Cagan says.
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| ARM debt and 'reset sensitivity' |
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 Christopher Cagan, director of research
and analytics for First American Real Estate Solutions, estimates that ARMs account
for almost 40 percent of mortgages that were originated in 2004 and 2005, accounting
for $1.9 trillion in ARM debt. Of those loans, about $431 billion started out
with rates at 2.5 percent or less. The borrowers with those loans have the highest
risk of not being able to make their payments when the rate adjustment arrives,
because their rates could double, or come close to doubling, in a short period.
He assumes
that a lot of these mortgages are payment-option
ARMs. Since a minimum payment doesn't even
cover the interest accrued that month, the balances
on these loans can rise to 15 percent or 20 percent
above the original balance. That in itself can endanger
borrowers. According to Cagan's calculations, 51 percent
of these borrowers have less than 15 percent equity
in their homes. They could end up in double trouble:
unable to make their minimum monthly payments after
the loan rate adjusts, while owing more than the house
is worth.
Of this riskiest
group -- people who have less than 15 percent equity
in their homes, and who got ARMs with teaser rates of
2.5 percent or less, Cagan estimates that 90 percent
could default, resulting in $198 billion in foreclosures
over several years. The loss to lenders and investors
will be less than half that, after they sell the foreclosed
homes.
That's
a lot of money. But when you consider that the nation's residential real estate
is worth more than $19 trillion, and homeowners have more than $8 trillion in
mortgage debt, it's a problem that can be managed. |
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