In the midst of the upheavals surrounding the subprime
market a new study has emerged that appears to quantify the problem and,
at the same time, offer hope that it isn't as bad as it seems.
Christopher L. Cagan, Ph.D., Director of Research and Analysis of First American
CoreLogic recently released Mortgage Payment Reset: The Issue and the Impact.
Dr. Cagan utilized two large databases to conduct his study: information on
over 32 million single-family homes and condominiums and townhouses in 694 counties
and 41 states plus Washington, D.C and including over two thirds of the nation's
population; and a database consisting of 25.9 million active first mortgages
from all fifty states and the District. Each of these loans was originated between
2004 and 2006 and totaled $5.38 trillion. Both data sets are proprietary to
First American and its subsidiaries.
First American claims to be the nation's largest collector and provider of real
estate focused public record information, serving more than 600,000 users nationwide.
It collects data for its customers on more than 138 million properties annually
and on 4.5 million property and mortgage transactions each month; more than
99 percent of all transactions in the U.S.
The study looks at the possible results as adjustable rate
loans adjust and payments on those loans reset to long-term levels from several
- How much will mortgage payments change on a national basis?
- How will these reset payments impact on homeowner default and foreclosure?
- When will the impact actually...impact?
- How will changes in the real estate market mitigate or magnify the impact
of mortgage rate resets?
The study analyzed the data using techniques to classify market segments on both
a payment and an equity axis. On the payment side loans were quantified as relatively
safe or vulnerable under the pressure of mortgage payment reset and according
to its initial and fully reset rates to find the proportional increase in monthly
payments. Loans were put into a laddered arrangement with adjustments for time
and the type of loans. On the equity side a laddered arrangement was established
for time and loan type to classify each loan into one of five levels of equity;
assigning to each an associated probability of equity risk and level of influence
upon possible default. By examining both the risk of reset and the risk of equity
Cagan was able to build projections of overall default
when borrowers cannot make payments after reset and there is insufficient equity
to allow them to sell or refinance the property.
The highest reset impact is among those loans with the lowest initial rates;
generally the teaser loans with artificially low initial rates
often under 4 percent; even as low as 1 percent. The second greatest impact
is with market rate adjustable mortgages. Payment increases in this group can
be sizeable, but these borrowers more often have the financial capabilities
to survive the impact. Sub-prime loans may have resets that are actually proportionally
lower than market rate loans but these borrowers are likely to have fewer financial
resources or they would not be in the subprime category in the first place.
Mortgage payments are expected to change by $42 million per year. This amount,
however, represents only 0.36 percent of the $12-trillion dollar economy. Thus,
reset will not break the national economy but it will affect the subset
of loans subject to adjustment.
The study found that the risk of default due to rate reset will result in some
1.1 million foreclosures, but they will be spread out over
a total period of six to seven years. This number represents 13 percent of all
adjustable-rate mortgages originated for purchase or for refinancing from 2004
to 2006 and will total $326 billion in debt It is further projected that an
additional $112 billion will be lost post foreclosure and resale to remaining
equity, lenders, and investors, again spread over several years. "These losses
represent less than one percent of the total mortgage lending projected for
that period. Thus, mortgage payment reset will not break the national economy
or the mortgage lending industry."
This impact, however, will not be spread evenly. It will be the teaser-rate
and sub-prime mortgages originated in the last three years that will bear the
brunt of the reset. These loans will begin the reset processes earlier than
market-rate adjustable loans and are more likely to default.
The study projects that 32 percent of teaser loans will default due to reset
as will 12 percent of sub-prime loans while only 7 percent of market rate adjustable
rate loans will do so.
But these projections of foreclosure are sensitive to changes in home prices.
Because the default risk is a combined effect of higher payments and lower equity
even a small increase in house prices will lift homes into a positive or near
positive equity position and allow potentially defaulting buyers to escape difficulty
through refinance or sale. Conversely, a small decrease in housing prices will
have the opposite effect, increasing the risk of default. In fact, each one-percent
rise in national prices will result in 70,000 fewer homes lost to reset-driven
foreclosure while a one-percent fall in prices will cause an additional 70,000
homes to enter foreclosure.
The study also looks at remediation. External remediation such as might come
from government or another type of outside intervention is likely to happen
only after problems begin to occur. Therefore, regulators, lenders, and investors
should be aware that teaser-rate and subprime loans will be the "canary
in the coalmine."
Marketplace remediation has, according to the study, already begun. Borrowers
are, on their own refinancing out of risky loans and lenders are working with
clients to modify or refinance loans to avoid default.
One can assume from the results of the study that rate resets may cause a lot
of individual pain and some market discombobulation but that the overall economy
is strong enough to withstand the fallout which will represent only a small
percentage of the mortgage market.