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Coming Soon: Mortgage Payment Resets

Posted By Barry Ritholtz On March 13, 2006 @ 6:02 am In Economy,Real Estate,Retail | Comments Disabled

You may have missed this over the weekend: The Saturday WSJ [1] reports that "More than $2 trillion of U.S. mortgage debt, or about a quarter of all
mortgage loans outstanding, comes up for interest-rate resets in 2006
and 2007, estimates Moody’s Economy.com, a research firm in West
Chester, Pa."

Let’s repeat that number:  Over the next 20 months, more than two trillion dollars worth of adjustable rate mortgages will reset at higher interest rates.

Now, I don’t want to be accused of being a perma-bear [2] or anything like that, but I am having a hard time trying to figure out exactly how anyone can spin this into a positive: Dark matter [3]? Credit Surplus [4]? Real Estate Boom [5]?

I’m at a loss for words spin.

Perhaps a chart may help: Not only do we have a significant mortgage debt reset acomin’, but a huge chunk of it is subprime. That means the debtor’s are those least able to handle the monthly increase. Nice. 
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Reset__20060310175409 [6]WSJ [1]
"Millions of Americans who stretched themselves financially to buy homes face a painful adjustment — some could even lose their houses — as monthly payments on adjustable-rate mortgages are reset higher.

In the hot housing market of recent years, many households took advantage of "affordability" mortgage loans — heavily promoted by lenders — that hold down payments for an initial period. Now the initial periods are coming to an end on many of these loans, leaving borrowers to face resets of their interest rates that can cause monthly payments to shoot up between 10% and 50% . . .

Resets will "eat into discretionary spending" for many Americans, says Joshua Shapiro, chief U.S. economist at MFR Inc., an economic consulting firm in New York. He expects consumer spending to slow in the months ahead but says the job market remains strong enough to keep most people out of serious trouble."

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Sure, that sounds pretty bad, but how awful can it be? Well, the worst case scenario is a wave of defaults, foreclosures, and forced sales, forcing home prices appreciably (depreciably?) lower.

Hopefully, many of the defaults will refi and avoid foreclosure. (Gee, I hope Carmella’s Spec house wasn’t variable mortgaged).  But the macro impact will clearly be on consumer spending; Not only will this group of non-saving, free spending consumers have their budget’s crimped by their increased mortgage costs, but their ready source of equity to borrow against goes buh-bye. This does not end well . . .   

One title insurer ran the numbers, and they project that of the adjustable rate mortgages written over the past 2 years, as many as 1 in 8 (12.5%) will end up in default:

"Most borrowers will be able to cope with the coming wave of resets, in
some cases by refinancing with new loans, lenders and mortgage industry
analysts say. But some borrowers will have trouble meeting the higher
payments and may be forced to sell their homes or could lose their
homes to foreclosures. A recent study by First American Real Estate
Solutions, a unit of title insurer First American Corp., projects that
about one in eight households with adjustable-rate mortgages that
originated in 2004 and 2005 will default on those loans."

Its hard to imagine how without a significant uptick in economic activity, (by definition) a recession is unavoidable no later than the end of 2007. We believe that when looking back in hindsight from 2008, there’s a very real possibility that the recession will be marked as beginning towards the end of 2006.

If and when this happens, there are two classes of goats for the lynch mobs to single out: Those clowns who insisted that the U.S. savings rate is not actually negative (thanks to home appreciation!), and those members of the sunshine crowd who insist that this imbalanced structurally unstable, economically disparite economy was just fine.

If you think Santa’s list of who’s been naughty and who’s been nice is tough, just wait until you see mine . . .

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UPDATE: March 15, 2006 5:49am

A quick back of the envelope calculation shows that the resets results in an additional monthly mortgage payments of $1.241 Billion per month per 1% increase, or ~$15B in additional mortgage payments per year per 1% increase.

That’s not insignificant, but it is dwarfed by the much bigger macro issue of the loss of cash out refis — which have been a major driver of consumer spending.

Former Fed Chair Greenspan estimates that over $600 billion in cash out refis took place in 2004 — that dwarfs the increase in monthly payments.  Goldman Sachs estimates that in 2005, it was $834 billion. The expectation is that consumers spent 68% of that money.

For more details see:  Real-Estate Boom Soon May Sputter As an Engine of Retail Sales [5] and GDP w/o Mortgage Equity Withdrawal [7]

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Sources:
Millions Are Facing Monthly Squeeze On House Payments [1]
Many Adjustable-Rate Loans, Popular in Recent Years, Will Soon Be Reset Higher
JAMES R. HAGERTY
WSJ, March 11, 2006; Page A1
http://online.wsj.com/article/SB114204536747195612.html

Do Homeowners Know Their House Values and Mortgage Terms? [8]
January
2006   
http://www.federalreserve.gov/pubs/feds/2006/200603/index.html

NEW STUDY INVESTIGATES MORTGAGE PAYMENT RESET [9]
First American Real Estate Solutions, Feb 14, 2006
http://www.firstamres.com/pdf/02-14-06RES-ResetStudy-FINAL.pdf

Mortgage Payment Reset: The Rumor and the Reality
Christopher Cagan, Ph.D
First American Real Estate Solutions


Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2006/03/coming-soon-mortgage-payment-resets/

URLs in this post:

[1] Saturday WSJ: http://online.wsj.com/article/SB114204536747195612.html

[2] perma-bear: http://bigpicture.typepad.com/comments/2006/03/you_know_you_ar_2.html

[3] Dark matter: http://bigpicture.typepad.com/comments/2006/02/businessweek_co.html

[4] Credit Surplus: http://bigpicture.typepad.com/comments/2005/10/more_glut.html

[5] Real Estate Boom: http://bigpicture.typepad.com/comments/2005/11/read_it_here_fi.html

[6] Image: http://bigpicture.typepad.com/photos/uncategorized/reset__20060310175409.gif

[7] GDP w/o Mortgage Equity Withdrawal: http://bigpicture.typepad.com/comments/2005/12/chart_of_the_we.html

[8] Do Homeowners Know Their House Values and Mortgage Terms?: http://www.federalreserve.gov/pubs/feds/2006/200603/index.html

[9] NEW STUDY INVESTIGATES MORTGAGE PAYMENT RESET: http://www.firstamres.com/pdf/02-14-06RES-ResetStudy-FINAL.pdf

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