The US housing crisis isn't over — not by a long shot. In fact, federal and state officials are bracing for the next tidal wave of foreclosures — adjustable rate mortgages (ARMs), particularly option payment ARMs.
Option ARMs let borrowers choose to make very low payments for the first five years. During that initial period, borrowers can pick their payment option.
That's where option ARMs differ from other ARMs; borrowers have the option to pay interest only, or a minimum monthly payment that doesn’t even cover the interest. This results in a rising loan principle, or what's called negative amortization.
When the balance of the loan reaches a certain level, or the mortgage hits a specific date, the borrower must begin making full payments to cover the new amount. The loan's interest rate also may have been fixed at a low level for the first few years with a so-called teaser rate, but can then reset to a new higher level.
Because the new monthly payments can be five or 10 times what borrowers are accustomed to paying, most of these borrowers are eventually overwhelmed. In most cases, borrowers owe much more than their homes are worth, so they cannot refinance their way out of trouble.
According to Fitch Ratings, 94 percent of option ARM borrowers elected to make minimum payments only. That portends the trouble that lies ahead.
We are already in the midst of the worst housing downturn since the Great Depression, and things are about to get worse.
Next year, many option ARM payments will begin to readjust, slamming borrowers with dramatically higher monthly mortgage bills. That will unleash the next big wave of foreclosures.
Option ARMs became widespread starting in 2005, which is why the recasts and higher payments will pick up steam in 2010, five years later.
The bulk of option ARMs recast dates are spread out from 2010 through 2012, meaning the foreclosure waves could drag on for the next few years.
Option ARMs tend to be "jumbo," or for significantly large amounts, making it even harder for borrowers to avoid foreclosure. Even though most option ARMs have not yet adjusted higher, many borrowers are already defaulting anyway. That's an ominous sign of what's to come.
There are 2.8 million active interest-only loans nationally, worth a combined total of $908 billion. In the next 12 months, $71 billion of interest-only loans will reset. Even after mid-2011, another $400 billion will reset. California will be particularly hard hit; in 2004, nearly half of all Golden State buyers took out an interest-only loan.
Banks never gave out loans with 10 percent unemployment in mind, and the massive losses will continue to burden their balance sheets.
Nationally, home prices have already declined by nearly one-third, peak-to-trough, since 2006.
However, respected banking analyst Meredith Whitney predicts that high unemployment will result in a further 25 percent drop, resulting a total decline of about 50 percent.
“I think there is no doubt that home prices will go down dramatically from here; it’s just a question of when,” Whitney told CNBC on September 10. “If you look at the drivers for unemployment, I don’t see that reversing very soon.”
There is already a huge supply of unsold homes on the market. Adding a glut of additional foreclosures will likely depress home prices for years to come.
Moody’s now forecasts that some home prices may not return to their pre-recession levels until 2030. This means that hundreds of thousands of Americans may find it impossible to sell their houses without paying off banks for underwater home loans.
At a minimum, Moody's says that many states (i.e. NY, IL, CA, FL) will not recover until sometime between 2018-2024.
If it does indeed take 15-20 years for housing to recover, that amounts to a lifetime for many older Americans.
The new reality is that Americans are going to have to return to a more traditional view of a house; a place to lay your head and make your home.
Houses will no longer be viewed as investments, much less get rich quick schemes.
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