We've been talking a lot recently about the "next wave" of foreclosures that would be driven by adjustable rate mortgage resets. In a research note today, FBR's Paul miller is taking an interesting tack: "While we remain very concerned about the impact of continued job losses on default rates, our analysis suggests that payment shock from ARM resets should not be a problem, as long as the Federal Reserve can keep short-term rates at record lows."
At face value, that makes total sense. Interest rates on the 30-year fixed are hovering just above 5 percent, historically low by any measure. Borrowers may, as Miller notes, benefit from the rates resetting lower. How much are we talking here? Miller:
While it is very hard to quantify the exact outstanding amount of any one type of mortgage, as banks do not really give detail down to the loan type, we know that $5.3 trillion in ARMs were originated from 2003 to 2006. Additionally, ARMs composed 45% to 50% of the origination market from 2004 to 2006. We estimate that there are roughly $500B of option ARMs outstanding, with roughly $150B expected to reset over the next two years, and another $1T of 5/1 IOs outstanding, of which $200B to $300B are expected to reset in the next two years.
Now here's my problem with Miller's thesis. Many of the ARMs that we're talking about are "pay option ARMs". These were those wonderfully innovative and unique loan products that enticed so many borrowers/investors during the height of the housing market to jump into loans they could never afford. Why? Because you can choose to pay whatever you like for a while. So guess what most borrowers chose? And then it comes back to bite you. Yes, many of these loans could reset to manageable rates, but they will also hit the limit, that is when the amount deferred hits a certain percentage of the total loan and then is required to be added on to the monthly payment. At that point the interest rate will have much less to do with the amount of the monthly payment.