The concept of rate
shock is getting a lot of press and a portion of it is pretty scary. Here
is a compendium of things that are being said about potential rate adjustments
of ARMs, option mortgages, and who might bear the blame if there is what one
article termed "a neutron bomb" that would wipe out the borrowers while leaving
the houses standing. There are, of course, always individuals and companies
that will benefit from any catastrophe and those are also getting their share
of attention in the press.
BusinessWeek.com has just published a stunning article (resulting in the neutron
bomb reference above, ) that postulates that the fallout from
"exotic"
mortgages - i.e. interest only and option mortgages - will reach far
beyond homeowners who took on these obligations either not understanding the
ramifications or thinking they could game the system. According to the article
Nightmare Mortgages, Wall Street, and especially hedge funds (in which
many individuals, 401(k) and traditional pension programs invest) have also
bought these loans and the risks associated with them. "The
option
adjustable rate mortgage might be the riskiest and most complicated home
loan product ever created. (It) brought a whole new group of buyers into the
housing market, extending the boom longer than it could have otherwise lasted."
However, the article continues, there was more going on behind the scenes. Brokers
were
paid more to sell option ARMs than other mortgages and
lenders were allowed to claim the full monthly payment as revenue even if the
borrower paid the minimum and the loan's interest rates and fees might have
been set by hedge funds rather than the banks.
The article claims that banks don't have to report on the number of these
option loans they have written but they represented "at least 12.3 percent
(of all mortgages written) during the first five months of this year."
While they have been popular on the coasts where the market is especially overheated,
"through March 31 of this year, at lest 51 percent of mortgages in West
Virginia and 26 percent in Wyoming were option ARMs."
And, not only did these exotics prolong the boom, they may well worsen the
bust. "They also betray such a lack of due diligence on the part of lenders
and borrowers that it raises questions of what other problems may be lurking.
And most of the pain will be borne by ordinary people, not the lenders, brokers,
or financiers who created the problem."
However, while the author of Nightmare Mortgages feels that "ordinary
people" will bear the pain, it is not prudent to overlook the fallout that may
affect investors and banks. If lenders are indeed booking non-existent payments
and then are hit with massive defaults with no hope of recovery
we could be looking at some devastating damage upstream. The cavalier attitude
toward commercial real estate lending in the 1980's led to massive failures
of banks and savings and loans in the 1990s. One can only hope that this left
some sort of an impression on those institutions that survived that debacle.
BusinessWeek.com also says that the option ARM is not necessarily a product
whose time has come and gone. "Despite the housing slump, option ARMs
totalling 77.1 billion were written in the second quarter this year."
The complete Business Week article is available here.
And, as BusinessWeek.com noted, in spite of the recent bad publicity attending
the "exotic" mortgages, they continue to be promoted and publicized.
Motley Fool has an interesting article this week in which the writer, Seth Jayson,
waxes furious about an ad running in a Washington, DC area newspaper placed
by a major national homebuilder. The ad offers "a variety of living arrangements
at what seem like rock-bottom prices." For example: "3-4 bedroom garage
townhomes... $1,174 per month." Or this one: "Single family and manor
homes... $1,478 per month."
However, the builder discloses, "in microscopic print, that these payments
are in fact based on teaser (interest) rates of 2.75%, a rate that disappears
after one year. After that, you're stuck with a 6.25% rate on a 40-year mortgage.
You got that right, 40 years".
Using the big builder's own on-line calculators, Mr. Jayson played with these
"teaser" offers and he says, "...forget $1,174 per month my
friend." After that first year is over and the mortgage adjusts payments go
toward $2,081 per month. That's right, 75 percent higher than the teaser payment
in the ad -- which seems to exclude insurance, taxes, and mortgage insurance.
Here is one explanatory table offered by Mr. Jayson.
| |
Teaser Rate |
Years 2-40 |
30-Year |
| Payment & Interest |
$1083 |
$1788 |
$1940 |
| Tax & Insurance |
$183 |
$183 |
$183 |
| Mortgage Insurance |
$110 |
$110 |
$110 |
| Total Monthly Payment |
$1376 |
$2081 |
$2233 |
These figures assume a $350,000 home, 10% down payment, and the builder's
auto-generated tax and insurance figures which Jayson stated he thought were
on the low side of reality. As you can see, there's an incredible difference
between ad copy and abject reality
Mr. Jayson does a good deal more number crunching in his analysis which can
be read in its entirety here.
A lot of people will only be too happy if rate shock starts shaking people
loose from their homes or causing financial upheaval. There are several websites
that make their money by dealing in foreclosures and investors who sit on the
sidelines just waiting for a disaster to happen. They are apparently doing very
well.
A bit more about this later in the week.