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Special section Mortgage reset

Adjustable mortgages with low introductory rates were the rage, but now the teaser rates are running out.

What is a reset?

Study: Flood of foreclosures coming

You have a 1-in-3 chance of losing your house to foreclosure if you got an adjustable-rate mortgage, or ARM, in 2004 through 2006 that had an initial teaser rate of less than 4 percent.

If you got a subprime ARM in that period, you started out with a higher rate, and that puts you at less risk. You have a 1-in-8 chance of losing your home.

That's the takeaway message from a densely detailed report by Christopher Cagan, director of research and analytics for First American CoreLogic. Cagan's study focuses on 8.4 million ARMs that were originated in 2004, 2005 and 2006. About 1.1 million of those borrowers will lose their homes in the next six to seven years because of payment shock brought on from rate resets or loan recasting, Cagan estimates.

The Mortgage reset calculator offered by Bankrate can help you determine what your own ARM payments will be after it adjusts.

Cagan assumes that property values will remain relatively flat from their December 2006 levels. If house prices fall -- and in many markets, they already have fallen in the first three months of this year -- foreclosures will be higher than his estimates. If house prices rise, there will be fewer foreclosures than forecast. Each 1 percent rise or drop in house prices will translate into roughly a 70,000 decrease or increase in foreclosures.

"These losses are (from) reset only," Cagan says. "I do not study job loss, death, divorce, illness or fraud." For example, the foreclosure rate is high right now in Detroit, but that has little to do with low-rate teaser loans or subprime ARMs. Job losses are driving foreclosures in the Motor City.

Pain will linger
It's important to remember that Cagan's estimate of 1.1 million foreclosures is forecast to occur over the next six or seven years, not all at once. He says much of the pain will be felt next year and the year after.

The "pinch year" is 2008, he says. "That is the pileup of 2/28s originated in 2006 at the peak of the market. And also, you have the 3/27s starting in 2005. Those two years are the peak market years; also very generous lending years, so you had the peak of the market, with people borrowing with nothing down or 5 percent down."

When Cagan talks about the peak of the market, he's talking about house prices. In much of the country, especially along the coasts, prices peaked in 2006. If you borrowed 100 percent or 95 percent of the home's value in 2006, you immediately were under water, owing more than you would get if you immediately sold your house and paid a real estate commission.

Subprime ARMs: 2/28, 3/27
Most subprime ARMs are 2/28 mortgages, which start out with an introductory rate that lasts two years, and then are adjusted every six or 12 months thereafter. Subprime 3/27 mortgages have an introductory rate that lasts three years.

-- Posted: April 18, 2007
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