June 24 average daily rates in Orange County for 30-year fixed loans with one-point fee: Conforming up to 6.078%, Jumbo up to 7.446% and Conforming-Jumbo up to 7.208% (Note: conforming-jumbo rates are for loans from $417,000 to $729,750, while conforming is up to $417,000 -- both types are sold to GSEs. Jumbos here are $730,000 or higher and not sold to GSEs.)
Source: Newspaper Chart Services 
Option ARM delinquencies rise
December 28th, 2007, 12:59 pm · 11 Comments · posted by Matt Padilla, Register Reporter and Blogger
Looks like the LA Times discovered more folks are missing payments on option ARM loans, which allow borrowers to pay less than interest owed, with the unpaid interest tacked onto the loan balance.
The story is interesting, but neither the article nor the Standard & Poor’s report it refers to give any historical context to option ARM delinquencies. The Times, quoting S&P, says delinquencies of 90 days or more have hit “3.7% of all option ARMs.”
First of all, I had S&P e-mail me the report, and the 3.7% only refers to loans made in 2006 not “all option ARMS” as stated in the Times. (The authors of the S&P report were not immediately available for comment but a media spokesman for the company agreed that the delinquency number only refers to loans made in 2006, which S&P analyzed.)
More importantly, S&P didn’t provide delinquencies for option ARM loans made in past years, so we don’t really know how dramatically missed payments are increasing. S&P looked at option ARM and other Alt-A loans, which are generally to folks with pretty high credit scores, but special circumstances, such as just stating their income instead of proving it.
One key fact in the S&P report: More than 75% of folks with an option ARM loan have been making the minimum payment, which is subject to negative amortization. It’s not clear from the report if that figure is for all option ARM loans or just those made in 2006.
Borrowers can keep making the minimum until the balance rises to 110% to 115% of the original balance. S&P said it expects delinquencies and losses to “rise sharply as loans reach their negative amortization ceiling.”
One way readers of this blog know option ARM delinquencies have been on the rise locally is by Mortgage Insider following the fortunes of Newport Beach-based Downey Financial. Downey has specialized in option ARM loans in Southern California. Here’s a monthly chart showing its nonperforming assets — delinquent loans and foreclosed real estate — as a percentage of total assets. The % keeps rising both because its total assets generally are falling while delinquencies and REOs, or real estate owned, generally are rising.
December 28th, 2007 at 1:17 pm
Matt,
What is the title of the S&P report?
December 28th, 2007 at 1:48 pm
Option arms were designed to be only an investment and liquidity tool for the ultra-wealthy decades ago. The idea; take the money you’re not paying on the mortgage and invest it into some side fund earning a high return rate so it offsets the deferred interest on the mortgage. Sure your balance may go up 15% on the mortgage over the next 4 years, but you’d have all the cash liquid and by the time you do your refi, you’d be even or ahead, and not have all your eggs in one basket (being the equity). That was a great idea when indexes were low and IF someone really did invest 100% of the savings. Unfortunately, where the mortgage industry went wrong, is that these loans were allowed for everyone. There should have been some kind of income to purchase price ratio in place so people couldn’t buy a home that was 200% more than they could afford. But of course as long as lenders saw quick profit they allowed these fundings to go on for years, many times with customers not even realizing how the loans worked. I deal with loan officer’s daily for my job and many of them barely understand all the moving parts in some of these tricky loans. So how they explained them correctly to their clients, I have no idea. I expect these loans to go away for good. At lenders like Countrywide now, I believe you have to not only qualify at the fully indexed rate (index + margin), but they also add in the potential neg am being added to the loan balance when trying to figure out who qualifies for the loan. So basically it will be darn near impossible for anyone who’s not very wealthy to get these loans now. Why would someone even try for an option arm when they can go qualify much more easily for a 30-year fixed at 6%. The loans are all but dead and it’s a great thing. The loans were abused by not only the greed of the loan people and lenders, but also the home owners who wanted a mansion on a condo budget.
December 28th, 2007 at 2:53 pm
To Cal,
The report is titled “The Spotlight’s On U.S. Alt-A RMBS Issuers as Performance Deteriorates Rapidly.” It was emailed to me or I would have posted link.
-Matt
December 28th, 2007 at 4:00 pm
I think the important point is that these loans were made in significant volumes in 2006 and 2007 and are being ignored in the discussions about the upcoming “reset” waves. Most people made the minimum payment on these because they had no hope of paying the fully amortizing payment (or in many cases, even the interest only payment). Because of this they are really more completely dependent on a refinance than even the ARM loans. The upcoming default wave is not being tracked because there is no scheduled “reset deadline”, but make no mistake, most of these loans are steadily proceeding to that 110 -115% max limit and a mandatory fully amortizing payment on a loan balance equal to 110 - 115% of the original loan balance. With values flat or falling refinance will be no option (nor will a “bailout” be available since they designed to exceed a 100% LTV on the original value). These loans will in most cases move directly to forecosure since they are designed to be refinanceable only if values increase significantly during the pay option period (by at least 20%).
December 28th, 2007 at 5:01 pm
If people were investing their savings like they are supposed to do with these loans, they would probably about break even with the negative equity. Then they could refi if values weren’t crashing. So it’s a double-edged sword. Nobody’s saving the difference because they bought a house they couldn’t afford to begin with, and values are going down now as well. So they’re losing equity x2.
December 28th, 2007 at 7:19 pm
As a former mortgage loan officer, I can’t even begin to count how many customers would “shop” an option ARM with a 1.75% teaser rate against a traditional 30 year fixed rate mortgage product. Despite my attempts at explaining the potential financial disaster at taking on such a risky loan, customers would opt for the option ARM because they believed (urged by frenzied Realtors) that there would be no problem unloading the house at a profit if things got rough. This article is describing only the tip of the iceberg. The worst is yet to come.
December 28th, 2007 at 9:57 pm
Matt,
Thanks for posting the name of the report.
December 29th, 2007 at 11:43 am
Lou:
I could not agree with you more.
People purchased on the assumption that they will sell at a profit or simply refinance.
Let us not forget that is exactly what has been happening the last 6 years.
December 29th, 2007 at 11:05 pm
What I find to be absolutely stunning is that 3.7% of these loans are in default before they have reset or recast. With a minimum payment of probably half the full P&I amount, how can people not afford to pay the minimum amount?
I think the final losses from these loans will be absolutely breathtaking.
December 30th, 2007 at 1:58 pm
Tanta at Calculated Risk explained the time line for neg-am resets. She posted and explained this info a few weeks ago or maybe longer back than that. Although I cannot recall exact details, the gist is that negative amortization occurs at a rate limited by the terms of the loan, so that (if I recall correctly) it takes about 5 years to begin reaching the reset limit.
What this means is that the California downturn is likely to continue for a long time. NegAm borrowers are probably going to have a default boom in about 2010 and 2011, with defaults and short sales rising in the meanwhile, not to mention an explosion of nervous ticks and other psychosomatic symptoms in posh neighborhoods like westside LA and coastal OC . . .
Slow motion pain . . .
It will be intersting to see if the NegAm folks keep paying their monthly mortgage bills in 2008 and 2009 as more of them begin to see clearly the default coming at them at the speed of time………….I think many will start to see it coming and, as they do, short sale listings will rise sharply.
Joe
December 30th, 2007 at 6:12 pm
this article should be required reading for
all bloggers this is whats happening and
whats going to happen and WHY…
http://blogs.marketwatch.com/greenberg/2007/12/straight-talk-on-the-mortgage-mess-from-an-insider/