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The following chart of mortgage resets was published in early 2007.

This chart shows a tremendous number of subprime mortgages reset in 2007-2008. Many of these defaulted, causing the financial crisis.

This chart shows a lull in mortgage resets in 2009. Then there is a great bulge in Option-ARM and Alt-A resets in 2010-2011. Since these are weak mortgages, many can be expected to default. This could abort any 2009 recovery.

It is very important for METARs to have timely, accurate information to predict the trend of housing and the economy.

I inquired on the Buying and Selling a Home board about this. Aj486 said that she believed that many of the Option-ARM mortgages had already failed.

Option-ARMs are credit card like deals, where the borrower can pay a minimum amount that does not cover either interest or principal. A borrower who does this has "negative amortization" -- the balance increases instead of decreasing. However, when the owed amount reaches a reset value (110%-120%), the mortgage resets to a higher fixed rate.

Aj486 also said that she thought that many Alt-As had already reset. Because interest rates dropped, this would lower the monthly payment. Aj486 also said that many Alt-As had already been refinanced and would not fail, due to lower interest rates.

If true, this would significantly change the data in the 2007 chart. If Alt-As and Option ARMs have already been refinanced, failed or modified in 2009, the bulge in 2010-2011 would be lower, and there would be less danger in those years.

But aj486 did not present data.

I have been dubious that a significant number of Alt-As and Option-ARMs have been refinanced. That is because these "nontraditional" mortgages were widely used in the bubbliest areas -- areas where home values fell fastest and farthest after the bubble burst. Many of those homes are deep underwater. Their owners probably don't have the assets (or the will) to refinance, because they would have to pay off the original mortgage with a big chunk of cash.

I tried to get data from the Mortgage Bankers Association. Unfortunately, they charge for their data.

Today, I discovered the Federal Housing Finance Agency (FHFA). This new agency was formed in late 2008 by a legislative merger of the Office of Federal Housing Enterprise Oversight (OFHEO), the Federal Housing Finance Board (FHFB) and the U.S. Department of Housing and Urban Development (HUD) government-sponsored enterprise (GSE) mission team. FHFA regulates Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks.

Here is the latest FHFA report on loan modifications.


March 17, 2009

Washington, DC – Federal Housing Finance Agency (FHFA) Director James B. Lockhart submitted to Congress FHFA’s latest report as a Federal Property Manager (FPM) detailing actions it has taken to prevent unnecessary foreclosures. The report shows a 76 percent increase in loan modifications by Fannie Mae and Freddie Mac from the third to fourth quarters of 2008. There were 23,777 loan modifications during the fourth quarter, compared to 13,488 during the third quarter.
“These data reflect that the post-conservatorship programs are starting to work to prevent foreclosures, even before the implementation of the streamlined modification program (SMP) in January,” said Lockhart. “I believe that the Making Home Affordable loan modification and refinance programs, building upon Fannie Mae and Freddie Mac’s SMP should cause loan modifications to accelerate. These more aggressive modifications should help lessen redefaults and better stabilize the housing market and neighborhoods.”…
As of December 31, 2008, the report shows that of the Enterprises’ 30.7 million residential mortgages:

• Loans 60+ days delinquent (including those in bankruptcy and foreclosure) as a percent of all loans increased from 1.46 percent as of March 31, 1.73 percent as of June 30, and 2.21 percent as of September 30 to 3.02 percent as of December 31. When adjusted for the suspension of foreclosure sales, the rate would have been 2.98 percent.
[914,860 loans. – W]

• Loans 90+ days delinquent (including those in bankruptcy and foreclosure) as a percent of all loans, increased from 1.00 percent as of March 31, 1.19 percent as of June 30, 1.52 percent as of September 30 to 2.14 percent as of December 31. When adjusted for the suspension of foreclosure sales, the rate would have been 2.10 percent.
[644,700 loans. – W]

• Loans for which the foreclosure process was started as a percent of loans 60+ days delinquent declined from 8.29 for the first quarter, 7.81 percent for the second quarter, 7.20 percent for the third quarter to 6.44 percent for October 2008, 5.25 percent for November 2008 and 6.38 percent for December. When adjusted for the suspension of foreclosure sales, the rate would have been 6.46 percent.
[ 59,100 loans. – W] During 2008, February represented the peak at 9.22 percent.

• Loans for which the foreclosure process was completed as a percent of loans 60+ days delinquent decreased from 2.41 percent for the first quarter, 2.55 percent for the second quarter, 2.56 percent for the quarter to 2.33 percent for October, 1.73 percent for November, and .37 percent for December. When adjusted for the suspension of foreclosure sales, the rate would have been 1.27 percent.
[11,620 loans. – W] During 2008, July represented the peak at 2.89 percent.

• Modifications completed totaled 8,688 in December. This represents an increase over the 2007 monthly average of 2,884, the November 2008 year-to-date average of 5,420, and the prior three-month average of 6,622.

• Both short sales and deeds-in-lieu were at their highest volumes for the year. Short sales were reported at 2,261 versus a low of 516 reported for January, and the prior three-month average of 1,883. Deeds-in-lieu were reported at 234 versus a low of 62 reported for May, and the prior three-month average of 159. Compared to the prior year, 2008 total loss mitigation actions averaged 18,321 monthly, which was 2.33 times the 2007 average of 7,858.
[end quote]

Since Fannie Mae is the larger of the GSEs, I wanted to take a look at how many Alt-A and Option-ARMs they have.

The weak mortgages (Neg-Am, Alt-A, high LTV, subprime, and jumbo conforming) are a relatively small part of GNM’s book. Most of these are “private label, non-agency” loans, that were securitized by banks and non-GSE mortgage lenders.

Default rates from 2005-2007 are still on an upward trend.

According to the Federal Reserve, Alt-A mortgages have certain characteristics that make them even riskier than subprime.

Finance and Economics Discussion Series
Divisions of Research & Statistics and Monetary Affairs
Federal Reserve Board, Washington, D.C.

The Rise in Mortgage Defaults

Chris Mayer, Karen Pence, and Shane M. Sherlund

November 2008

Near-prime mortgages are made to borrowers with more minor credit quality issues or borrowers
who are unable or unwilling to provide full documentation of assets or income; some of these
borrowers are investing in real estate rather than occupying the properties they purchase.

Nearprime mortgages are often bundled into securities marketed as “Alt-A.”…

The fall in nonprime originations coincided with a sharp rise in delinquency rates. The
share of subprime mortgages that were seriously delinquent increased from about 5.6 percent in
mid-2005 to over 21 percent in July 2008. Alt-A mortgages saw an even greater proportional
increase from a low of 0.6 to over 9 percent over the same time period….

The median FICO score in subprime pools was around 615,
while the median FICO score in Alt-A pools was around 705. This risk characteristic, unlike
combined loan-to-values, remained flat over time.

On other observable risk dimensions, Alt-A mortgage pools appear riskier than subprime
pools. For example, investors are considered more likely to default on mortgages than owner occupants,
and about 25 percent of Alt-A mortgages were originated on investment properties, compared with about 10 percent of subprime mortgages.2 In addition, around 70 percent of loans
in Alt-A pools did not include full documentation of income, assets, or both (so-called low- or
no-documentation loans), compared with 35 percent of loans in subprime pools….

For Alt-A loans, instead of changing the assumed period of time over which borrowers
repay the balance, lenders often dropped the requirement that borrowers pay off any principal at
all in the early years of the mortgage. Forty percent of Alt-A mortgages involved only interest
payments without any scheduled principal repayment (only about 10 percent of subprime
mortgages have such an interest-only feature). Even more strikingly, another 20 percent of Alt-A
mortgages allowed the mortgage balance to increase over time (so-called “negative
amortization”); these mortgages are not found in subprime pools….

Initial mortgage rates on Alt-A floating-rate mortgages hovered around an
extraordinarily low 2 percent—this rate represents a four percentage point discount relative to
the initial rate that the borrower would have had to pay for a mortgage without a teaser…

…by July 2008, the delinquency rate on adjustable-rate Alt-A mortgages had
risen past 13 percent, while the delinquency rate on fixed-rate mortgages had risen over 5

…the distinguishing feature of the short-term hybrid mortgage—the change in the
mortgage rate two or three years after origination—does not seem to be strongly associated with
increased defaults, as least prior to early 2008….

…most of the defaults on short-term hybrids occurred
well before the end of the teaser period. Mortgage rate resets may yet cause difficulties going
forward: households trying to refinance hybrid short-term mortgages in 2008 and later face an
environment of stagnant to falling house prices and tightened underwriting standards. These
changes make refinancing more difficult and thus increase the chances of default (Sherlund,
2008). On the other hand, if short-term interest rates remain low, the payment shocks associated
with rate resets could be small….

Over the 2003–2007 period, originators of nonprime mortgages increasingly designed
and promoted products with lower monthly mortgage payments. By 2006 and 2007, more than
one-third of subprime 30-year mortgages had amortization schedules longer than 30 years, more
than 44 percent of Alt-A loans allowed borrowers to pay only the interest due on their
mortgages, and more than one-quarter of Alt-A loans gave borrowers the option to pay less than
the interest due and thus grow their mortgage balances (so-called “option adjustable-rate mortgages”). Because borrowers pay down principal more slowly, if at all, with these mortgages,
loan-to-value ratios remain elevated and borrowers have a higher incentive to default….

The vast majority of borrowers with option adjustable-rate mortgages appear to have
exercised the option to make small “minimum” payments on their mortgages. By making
payments less than the accrued interest due, these borrowers increased, rather than decreased,
their mortgage balances over time….

These products generally only allow borrowers to make minimum or interest-only
payments for a period of time, usually five to ten years. At the end of this period, the payment
“recasts” into a payment large enough to pay off the mortgage balance in full by the end of the
mortgage. This recast can result in a substantial payment increase for at least three reasons: the
borrower now has to repay principal; that principal may have increased since the mortgage was
originated if the borrower only made minimum payments; and the borrower has to pay off the
principal over a shorter period of time than the original 30 years….

Serious delinquency rates on option adjustable-rate mortgages have risen even more
steeply than on Alt-A mortgages overall, increasing from 1 percent in January 2007 to 15 percent
in July 2008. Recasts, however, cannot explain this rise as most of these mortgages are not
scheduled to recast until 2010 or later. However, recasts may become a problem in the future if
house prices do not recover and refinancing remains difficult. The fact that so many option
adjustable-rate mortgage borrowers exercised their option to make only minimum payments—
and thus increase their mortgage balances—suggests that the size of these future recasts will be
especially large.

The no- and low-doc share for Alt-A loans rose more steeply from 62 percent in 2004 to
81 percent in 2007….No- and low-doc loans default at much higher rates than fully documented loans, and
prepay at lower rates (Sherlund, 2008). Over the 2005 to 2008 period, serious delinquencies on
no- and low-doc subprime mortgages rose from 5 to over 25 percent, compared with a rise from
5 to about 20 percent for fully documented loans….

Although borrowers with Alt-A mortgages tended to have a bit larger down payments
and thus more initial equity than borrowers with subprime mortgages, the negative equity picture
for Alt-A mortgages is surprisingly similar to the subprime picture. As of mid-2008, over half of
borrowers in California, Florida, Arizona, and Nevada, over a third of borrowers in Ohio,
Michigan, and Indiana, and over ten percent of borrowers in the rest of the United States had
negative equity….
[end quote]

The GSEs have 30.7 million residential mortgages. The majority of Alt-A and Option-ARMs are not at the GSEs. The FRB paper estimates of underwater borrowers show that millions of underwater borrowers will need to refinance.
This problem won’t be solved in time by 25,000 loan modifications per quarter.

I think that the data above shows that there will still be a big Alt-A and Option-ARM reset problem in 2010-2011 if interest rates rise. Even if they stay low, many Option-ARMs may default.

However, I am not a mortgage professional.

I hope that those who are expert in this business will look at the data and add their comments.

It is clear that the Federal Reserve will be forced to keep interest rates low in 2010-2011 to prevent the resetting mortgages from defaulting. Plan accordingly.

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