Rate resets: Crisis defused. So what?
Six months ago, an epic disaster was widely predicted. Interest rates on many adjustable-rate mortgage loans would rise sharply. Borrowers would be overwhelmed. Foreclosures would rise. It was said the number of resets would peak in the spring of 2008. Right about now.
Then the crisis was defused by the Federal Reserve, whose rate cuts reduced the magnitude of the resets. But foreclosures keep rising anyway. Has anyone been helped by the lower rates?
Just like every other respectable newspaper, we published an ominous piece last September predicting the consequences of the rate reset wave.
These rate increases will add hundreds of dollars to homeowners' monthly mortgage payments, and some housing specialists predict hundreds, and perhaps, thousands of borrowers will be unable to afford the higher costs.... "This is an unprecedented wave of resets," said Wellesley College economics professor Karl Case.... "People are getting hurt badly when their houses are taken away from them."
The good news: Everyone was completely wrong!
Few homeowners are defaulting after their loans reset to higher rates. A big part of the reason is that the higher rates aren't that high. In general, an adjustable rate increases by a fixed number of percentage points above a benchmark, such as the London Interbank Offered Rate (LIBOR). If your rate resets to five points above LIBOR, and LIBOR is 5.25 percent, your new rate is 10.25 percent.
The Fed's sharp cuts to interest rates have brought LIBOR and other benchmarks tumbling down. In September, the 6-month LIBOR -- one of the most common benchmarks -- stood at 5.535 percent. As of today, it is hovering slightly over 3 percent.
A person with a $300,000 loan whose rate reset in April could be paying $500 less per month than if the rate reset in September.
The bad news: It doesn't seem to matter.
Turns out many people with adjustable-rate loans couldn't even afford the introductory payments. A recent report from state regulators looked at the share of adjustable-rate loans past due, by the quarter in which the rate adjusts for the first time. For loans whose rates adjusted in the 4th quarter of 2007, 46 percent of the borrowers have missed at least one payment. But even for loans whose rates don't adjust until the 4th quarter of 2008, 39 percent already have missed at least one payment.
To bring that down to the local level, a new report from the city of Boston finds 77 percent of the city's foreclosures in 2007 resulted from defaults on loans with adjustable interest rates -- but in 72 percent of those cases, the interest rate had yet to adjust. The borrower couldn't even make payments at the introductory interest rate.
A recent research note from the Federal Reserve Bank of San Francisco summarizes the issue:
Much has been made in the news about the role of interest rate resets in causing delinquencies and foreclosures. After all, delinquency rates on variable-rate subprime loans are far higher and are rising much faster than those on fixed-rate subprime mortgages. However, research suggests that this has not been a major factor, at least so far.... It turns out that variable-rate subprime loans are more likely to become delinquent because the pool of borrowers that took out these loans had higher risk characteristics than those who took out fixed rate loans.
So the moderation of rate resets isn't affecting foreclosures. Is it affecting you? Are you better able to afford your home because the interest rate didn't climb as high as you might have feared?
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The bad news is what matters...
We have only just seen the bleeding edge of the housing decline with the weakest "homeowners" with the worst most toxic loans going bust.
Typical middle class "homeowners" are hanging on but not for long.
As various sentiment and other surveys show, American households are house-poor debt-laden and extremely dependent on stable employment particularly for dual-income households.
The era of relatively stable employment is over for this cycle and possibly could be in gone for quite some time as this major structural breakdown in our economy proceeds regardless of the herculean efforts by the Government and the Federal Reserve.
As for the housing dilemma, just look at the March results of home sales and prices for Massachusetts....
http://paper-money.blogspot.com/2008/04/collapsedachusetts-existing-home-sales.html
On a year-over-year basis:
Single family home sales down 32.3%
Condo sales down a stunning 38%
Single family median selling price down 8.4%
Condo median selling price down 5.3%
Multi Family sales down 20% in Q1
Multi Family median selling price down a whopping 28.4% in Q1
Pretty grim stuff and getting worse... look out below!
The first (primary) loan on my investment property is a 5 year ARM currently at 4.5%, and its first adjustment is this October. It's tied to the Treasury Constant Maturity rate plus 2.75%.
All winter, since the seriousness of the housing market decline became clear (to me anyway), I sweated out what to do. Refinance? Stay put and hope the Fed keeps dropping rates? Scary stuff for the average person. In the end I put faith in the Fed and they've come through. The CMT is currently 1.67% and will probably drop when the Fed drops rates again this month. If that rate is 1.5% in August when the lender recalculates, I'll be paying 4.25% -- a .25% drop from current payment. The adjustment caps at 2% per year as well, so I've bought not one year of reprieve but two, since I had always expected the worst and assumed I'd be paying 6.5% on the first adjustment. Now it could well be 6.25%, which I can afford.
Bottom line, I have the Fed and low rates to thank for buying me time. Ah, but what will mortgage rates look like in October 2010? Will I need to refinance? What will the property value be then? As an "accidental landlord" (we wanted to sell before buying a new house last year, but couldn't) I'm learning what a scary place the housing market can be!
I do think the biggest issue right now is the personal debt levels of the avg American consumer. the numbers will scare anyone.
With that said, I am now calling a bottom right here. The Bear Stears buyout/what ever you call it/ was the bottom for the stock market and the housing market will follow.
accidental landlord? it's either a landlord or not a landlord. It's not like you were randomly picked to be a landlord without your own accord. :) I could say I am an accidental husband LOL.
I have an ARM too. First mortgage at 4.25% and it schedules to adjust in two years. The adjustment cap is 2% per adjustment per year. The cap of the life of the load is 9%. When we signed up for ARM, we were well aware of it. We plan to live in the condo for no more than 7 years so we took a 7-yr ARM. We took into consideration even if we stay in the resident longer and/or the rate max at 9%, we could afford payment comfortably.
ni: Well yeah ok, it was a sober and conscious decision, just not my first choice. It happened fast. One minute X was going to buy my condo so I could buy the house I wanted, the next X backed out and I was scrambling to make it all work anyway. In some ways it certainly felt accidental. ;0)
You know when we took out the ARM I fully expected to move within five years -- and I was right. Unfortunately the market intruded on my grand plans. In retrospect my own unrealistic expectations for the price I could get was partly responsible.
But it has worked out. Rent covers housing costs at the moment. The renters are excellent and want to stay through 2009. Things could always go south when you're swimming with the adjustable sharks, but our cash flow is good and we have enough savings to take any serious hits.
The worst case scenario is that in the next three to five years rates soar and my property's value goes below the loan amount (the dreaded underwater). Then I can't refinance and end up losing money every month. There are several good reasons I don't think that will happen, but as I said these are scary days.
Dear Ted above,
If you think the Bear Stearns collapse marked the bottom of the housing market, do you also assume that if you kill one cockroach that your infestation is dealt with?
Housing prices won't collapse and recover inside of 12 months. This will take years to sort out, after all historical returns on real estate are about the same as inflation. That notion alone is very difficult for most people to get there heads around right now given the combo platter of a demographic shift back into cities and free money for the last decade. All the "above average drivers" also believe they are "above average" home buyers, until buyers refuse and are unable to over pay for real estate and sellers will be forced into dropping prices.
There is never just one cockroach.
Calling bottom now is just silly, and backed up by none of the actual stats - take a look at todays numbers.
On the post, I agree that it is correct as it stands - Fed intervention has had a big impact - but it leaves out the implications of "teaser rates"
A lot of people had rates that were so artificially low for the first few years that even at low LIBOR (around 2.91 right now) they can still see a point or 2 bounce on their interest rate on reset.
Doesn't sound like much, but a few hundred dollars is a lot to people who stretched beyond their means to get into a house in the first place, especially with fuel and food costs where they are. Those loans only made sense in an era of consistently rising house prices.
So yes, I'd say the reset rate hit will be lower than it could be. But it could still be very big, and even a minor addition of forced sales to this market won't be helpful.
I'm still saying bottom will be q3 of 2009, with flat appreciation for a while after.
You know, first time I read this, I complete skipped the second part of the post. On ninth read, I finally understood everything you were saying. Very interesting information.
I find it very telling that there have been so few comments on this post, compared to others. This is because, in my opinion, people can't refute the truth. When things go the opposite of what they want to happen, they have no choice but to avoid the conversation, entirely.
Or, put another way, you put the lights on, watch the cockroaches scatter.
Thanks John, I'm glad you found it interesting. I suspect the lack of comments also reflects a lack of clarity in my writing. Presumably not everyone has the patience to read my posts nine times.
This blogger might want to review your comment before posting it.
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