Another wave of foreclosures coming soon to the US market

An article in the Washington Post this morning reminds us of a major headwind now coming back to the foreground over the next several months: mortgage resets. Fitch Ratings estimates that 70 percent of the $189 billion in outstanding option ARMs will reset to higher payments by 2011.
Option ARMs, also called pick-a-pay loans, allowed borrowers to choose how much to pay each month. Nearly all the borrowers who took out this type of loan from 2004 to 2007 chose to pay less than the interest due. Sometimes they paid as little as 1 percent interest. But the loans eventually require the borrowers to start paying the principal and full interest rate. This rate reset will cause monthly payments to increase an average of 63% over more than $1,053 a month. This type of cost increase will be effectively impossible to pay for the hundreds of thousands of homeowners who bought too much house at bubble prices. (Not too mention those who are now unemployed).
The most severe problems have surfaced in states with the steepest price drops. About 75 percent of option ARMs financed homes are in California, Florida, Nevada and Arizona, where prices have plunged on average 48 percent from the second quarter of 2006 to the first quarter of this year. Most of the effected people will be unable to refinance into lower rate payments because their houses are now worth much less than the loans.
The overall impact of the Option ARM resets should be less than from Subprime over the past 2 years, but the drag of still increasing housing supply and the negative knock-off effects of more families going under are going to continue to be felt in the economy for at least the next 2 years, maybe longer.
See: Another Wave of Foreclosures Loom

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2 Responses to Another wave of foreclosures coming soon to the US market

  1. Anonymous says:

    Hi Danielle,
    With many concerns like future waves of residential and commercial foreclosures on the horizon and the recent seemingly unwarranted run-up on all the indices, do you advocate for staying in the markets or taking some profits with the expectation of a correction in the near future?
    Interested in your perspective. Thanks

  2. Anonymous says:

    I don't have much faith in the rally that has happened since June. March through May made some sense, but since then it seems to me things are now over-priced again in relation to the reality of the recovery and I find myself suspicious. That said I have also become a little sceptical of the idea of a major September-October pull back this year just because it seems to be so widely predicted now. A fall pullback after such a strong summer would be reasonable in my view, but reasonable outcomes often take longer than we like. I think we are still in a secular bear for sure, and that there will be another ugly leg down ahead, but no one can say for sure when it will happen. As a result, I would say keep a downside put on your equity positions here. You should have a stop or sell rule set for protecting your capital from the next leg down, and I think it is still wise to take some profit and be less than fully invested so that you have some cash to buy in at lower prices when they present. I would look to use any significant price weakness as an opportunity to add high yielding, high quality growth assets. But never forget we are in a secular bear and capital protection has to be always on your mind.

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