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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?

Low-rate ARM + low equity = danger

Foreclosures will rise over the next few years, experts agree. While each foreclosure is traumatic for the family that loses a house, the coming wave of defaults won't swamp the system.

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The borrowers in the most danger have two strikes against them. First, they are (or will be) under water -- owing more than the house is worth. Second, they have adjustable-rate mortgages, or ARMs, with low "teaser rates." Eventually, after anywhere from one month to five years, the ARM enters its rate-adjustment period and the loan is reset with a higher rate. Use Bankrate's helpful Mortgage reset calculator to find out what your own ARM rate could be after it is reset to a new rate.

Quite a few homeowners have these two strikes, and almost $200 billion in foreclosures will result, says Christopher Cagan, director of research and analytics for First American Real Estate Solutions.

Cagan prepared a 32-page report (PDF) in February that measured the extent of the risk to the mortgage market. It's not a financial-planning guide, but here's what consumers can take away from it: If you have an ARM with a teaser rate of 2.5 percent or less, watch out -- because the monthly payments could skyrocket -- even double -- after the rate is reset. And if, in addition, you owe more than the house is worth, you could find yourself in serious trouble -- unable to refinance and unable to sell without a loss.

Pretty common-sensical, really. That's why Larry Goldstone isn't all that worried.

'People are good people'
Goldstone, president of Thornburg Mortgage, based in Santa Fe, N.M., says, "Generally speaking, I think people are good people. They borrow money with the intention of paying it back."

When the business cycle moves down and people lose their jobs, more of them default, Goldstone says. It doesn't matter much if the borrower gets a 30-year, fixed-rate mortgage or something nontraditional, such as a payment-option ARM, in which the minimum payment doesn't even cover that month's interest.

David Greco, vice president of credit policy for MGIC, the largest insurer of mortgages, agrees that the loan type doesn't matter much. A precarious mortgage, he says, is one "where the likelihood that they'll be able to repay it is low, and I don't think there is anything that is inherently risky about any loan programs that are out there today."

Accurate assessment vital
The risk comes from the possibility that the borrower and lender didn't accurately assess the borrower's ability to repay, Greco says. One person might be able to handle a payment-option ARM with aplomb, while another person might wilt under a 30-year fixed.

That's not exactly how the federal government sees it. Regulators have proposed guidance -- essentially, a set of strong suggestions -- urging lenders to be more careful with interest-only and payment-option ARMs, especially in cases where the homeowner has little or no equity in the house or when the borrower produced little or no documentation of income and assets.

"The Agencies are also concerned that these products and practices are being offered to a wider spectrum of borrowers, including some who may not otherwise qualify for traditional fixed-rate or other adjustable-rate mortgage loans, and who may not fully understand the associated risks," the proposed guidance says.

Bankers worry that the guidance could result in fewer loans to deserving home buyers. "The question is, without these products, would we be better off? The answer is no," says David Herpers, chief marketing officer for Amerisave, a lender that specializes in customers with damaged credit. "I think, as a consumer, these emerging mortgage products are, overall, extremely beneficial."

Anthony LaGiglia, a financial planner with J.J. Burns & Co. in Melville, N.Y., isn't as sanguine about nontraditional mortgages. "When you look at interest-only mortgages, they were for a very select group of people -- a business owner or a Wall Street person who gets a huge bonus every year," he says. "But they're becoming more commonplace. A lot of people are utilizing them just to afford a house. A lot of people are getting in over their heads."

-- Posted: March 9, 2006
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