Losses from the 7.7 million adjustable-rate mortgage loans made since 2004 will not have a significant effect on the economy as the loans adjust and payments go up, says a study released Tuesday.
Defaults on ARMs could result in $110 billion in losses nationwide over the next five years, an enormous-sounding number that still comprises less than 1 percent of the home loans sold since 2004, according to Christopher Cagan, author of “Mortgage Payment Reset,” a study by First American Real Estate Solutions.
As adjustable-rate mortgages reach their adjustment date and payments jump, many have predicted problems if borrowers can’t keep up with the higher payments.
Economy.com, an independent research provider, says the overall delinquency rate for mortgage loans “is pretty much a straight upward path in delinquency between now and the end of 2007,” according to Celia Chen, its director of housing economics.
“It’s unpleasant, but it will not break the economy or the real estate market,” said Cagan, who studied valuations and mortgage debt for more than 26 million residences in a valuation database across 558 counties in 36 states and the District of Columbia, representing more than 60 percent of the nation’s population.
This is because loan losses will be spread out over the next four to six years, as not all distressed borrowers will find themselves in trouble at the same time, Cagan, an analyst with First American, said.
Adjustable-rate mortgages allow borrowers to make little or no down payments along with long monthly payments for a fixed initial period. After the fixed period, the payments adjust upward based on prevailing interest rates.
If rates rise sharply, the payments could rise sharply as well, increasing the risks that borrowers might default.
Cagan agrees that loan delinquencies will go up. “There will be four times more foreclosures than now. That we know,” the analyst said.
But, because the delinquencies will be a “time release” over the next four to five years, the economy will be able to weather the problems, Cagan said.
Cagan says his study is the first to calculate the amount of loan risk based on homeowner equity associated with hybrid ARMs, loans that allow borrowers to make little or no down payments and low monthly payments for the initial period.
Using data from LoanPerformance, a real estate research firm acquired by First American last year, Cagan found that the ARMs most at risk of default were those with low initial “teaser” rates of 2 percent or less, whose borrowers had less than 15 percent equity. This group represented about $70 billion in potential losses out of $1.8 trillion in ARMs issued in the last two years.
“I don’t think all adjustables are dangerous,” Cagan said. “If a person has a loan at 5 percent and it goes up to 6 percent, it’s not dangerous.”
The problem is, Cagan said, if a person is paying a 1 percent interest or option ARM at $800 a month ” and they get a letter saying their payments will now be $3,000 a month.”
Cagan examined loans made after 2004 because “people who bought in 2003 are in a good position because they have equity.”
If a borrower has equity and suddenly their payments skyrocket because the loan has adjusted, they can refinance to a longer-term, 15- or 30-year loan and bring their payments into line – or, if all else fails, they can sell their home. “But if they have no equity, it’s hard to sell and you can’t refinance,” Cagan said. People in this position are the ones most likely to default, he said.
Cagan noted that the market is already starting to impose limits in this area, with some Wall Street investors tightening up standards and refusing to pay as much for bundles of loans that are risky.
“Throughout human history there has always been a war going on somewhere. It doesn’t affect most people. But if, say, you’re an individual who bought with one of those teaser loans, or a broker who specializes in those loans, or an investor who bought them – you’re in the war zone,” Cagan said.
“You don’t want to be the person who gets hit with it, but it’s not going to break the country,” Cagan said.
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