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Subprime Resets

Written By Brian Hicks

Posted April 22, 2008

"The folks who say the housing market will stabilize anytime soon must be smoking some really strong stuff."
– Dean Baker, co-director of the Center for Economic and Policy Research in Washington.

With no money down, John C. was able to buy a home, a small two-bedroom house in California for $100,000. But he didn’t realize he’d just been hit with an interest loan that’d readjust higher two years later.

"My family and I didn’t know what an ARM was," he said. "It sounded like a good thing. I didn’t have to provide too much documentation. I now wish I was more educated."

Unfortunately, he’s not alone. Thousands are in the same boat, about to be saddled with crippling debt that could lead to higher mortgage delinquencies and foreclosures.

If you thought the subprime fiasco has been economically debilitating since 2007, just wait until 2009.

So when you hear of this mythical housing and credit market improvement, ignore the bulls and Wall Street hot shots that’d have you believe in a housing bottom, or the grand illusion of "priced in" credit market weakness.

Subprime mortgage resets may be coming to a near-term end, but Option ARM and Alt-A resets are just around the corner.


mortgage resets 042008


What should scare you is this – the coming Option ARM and Alt-A resets are similar to what we saw in early February 2007.

At that time, we said:

"Among the worst hit lenders will be the sub prime lenders, or those companies that make loans to borrowers with less than perfect or poor credit histories. While sub-prime lenders charged higher interest (two or three points higher than prime lenders) as insurance for the higher risk the borrower represented, rising foreclosures have left the sub-prime industry facing substantial fallout risks.

Sub-prime lenders could offer adjustable or teaser rates to those with bad credit. Loans like this made up 23% of the U.S. mortgage market in 2006 as compared to the 8% in 2001, according to Yahoo News. And it’s now a big problem as one in five sub-prime mortgages are now ending in foreclosure, according to the Center for Responsible Lending as mentioned by Yahoo News.

The Lending Market has not bottomed… nor has it priced in all negativity.

I’d love to sit here and jump on the bullish housing bandwagon that dominates Wall Street. Really, I would. But I’m not a fan of flushing my money down the toilet.

In reality, the housing market has not bottomed. Sub-prime lenders are doomed. You can continue to listen to the delusional madness pouring from the mouths of Street analysts, and the mainstream press, or you can listen to the homebuilder CEOs and the sub-prime lenders that have gone belly up because of a weak housing market.

Even JP Morgan’s CEO, James Dimon, is bearish on the sector, saying, "’Mortgages are the one area of sub-prime lending where we really see something taking place that looks like a recession….’"

That’s just an inkling of the tumultuous future for sub-prime lending. believed "The sub-prime sector still has another year of tough times ahead." That’s supported by Countrywide Financial, which says, "We’ve got another eight, nine, 10, 12 months of headwinds. You’re seeing 40 or 50 (sub-prime companies) a day throughout the country going down in one form or another. I expect that to continue throughout the year."

A recent Center for Responsible Housing report projects that "2.2 million borrowers will lose their homes and up to $164 billion of wealth in the process.

Even reported, "Signs of credit deterioration from the slowing U.S. housing market have already shown up in recent results of other banks as more borrowers fall behind. Foreclosures jumped 35% in December versus a year earlier, according to recent data from RealtyTrac. For the fifth straight month, more than 100,000 properties entered foreclosure because the owner couldn’t keep up with their loan payments, the firm noted.’"

Unfortunately, we all know how things turned out. How could you not see the disaster coming?

It’s the same question we ask today… How can you not see the next disaster on its way?

It shouldn’t come as a shock when mountainous Option ARM and Alt-A loans begin resetting and the second leg of the credit crisis begins.

Alt-A loans were given to borrowers with credit scores of between 620 and 700, and included the option of interest-only loans, option ARMs, and no documentation loans that required little if any documentation for loan approval. Ninety percent of those that got an Option ARM in 2006 provided little or no documentation.

Ninety percent!

And it’s estimated that only 60% of Option ARM borrowers make only minimum monthly payments. Others estimate that up to 80%.

Say a borrower makes minimum payments on a $600,000 loan. That loan could easily be a $750,000 loan within two years.

And we’re supposed to be shocked when this problem ends in the second credit crisis?

Just ask John C. who just mailed in his keys.

Ian L. Cooper