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The ARM Foreclosure Time Bomb is Ticking. Will it End with a Fizzle?

Does the recent increase in foreclosures signal the long-anticipated surge in defaults of adjustable-rate mortgages that were scheduled to reset their interest rates right about now?

That’s a question that came to mind when I noticed the recent uptick in new home foreclosures.

Option ARMs gave borrowers a choice of paying principal and interest, interest-only, or lower payments covering only a part of the interest and none of the principal. Most people paid on the low end, which increased their principal balances every month. Plus many of them had low “teaser” interest rates. These rates would reset after 5 years, or sooner if the principal balance reached a certain threshold, say 120% of the original amount. People could get more house for less money, but with a greater gamble that house values would continue to rise.

Since $600 billion worth of Option ARMs were made from 2005 through 2007, we are now right in the thick of when they were scheduled to reset. A similar flood of resets among subprime mortgages in 2006 and 2007 likely was a major cause of the “subprime mortgage crisis” which ignited the Great Recession. Around that time lots of smart folks were warning about this huge second wave of mortgage defaults and foreclosures that was to hit now.

But it’s not happening, or at least not nearly with the intensity anticipated. Why not?

1. Because many of these mortgages never got as far as their reset dates. They fell into default as the economy got worse and property values declined. They’ve just been part of the mix of mortgages in the foreclosure pipeline through these last two-three years.

2. Something like 20% of the Option ARMs have been modified by mortgage lenders and servicers, many into fixed-rate mortgages. Although mortgage modification efforts overall have been roundly criticized for their ineffectiveness, the lenders recognized their self-interest in avoiding the anticipated Option ARM defaults and so they were proactive with this category of mortgages.

3. Because the economy has been so slow in its rebound, interest rates have stayed extremely low for much longer than most anticipated. As a result the interest rate resets have increased mortgage payments much less than expected. In fact, in some cases mortgage payments have actually gone down.

4. Unlike subprime loans which mostly went to homeowners with shaky credit scores, Option ARMs went to borrowers with average or better credit. Those that have not already defaulted, and who are getting relatively modest payment increases at reset time, tend to be borrowers who can better afford to make the payments.

However, there still are millions of Option ARMs, most of which ARE requiring payment increases when they reset.  A large percentage of ARMs are at least 30 days late. So although the reset impact is not nearly as bad as many anticipated, with the very shaky economy many homeowners with these mortgages, even if they had decent credit a few years ago, are very vulnerable now.

If you have an Option ARM, or any other kind of mortgage, and need advice about your options, please come in to see me.

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