High-Risk Reset Trends

Submitted by Rich Toscano on February 6, 2008 - 7:48pm

A couple of readers responded to my prior article about the study on local mortgage resets to ask how the projected 2008 resets stacked up against those of 2007. The study's primary author, Joseph Galascione, consulted the archives for me and pulled out some stats on the number of high-risk resets expected each month as compared to the same month in 2007: January and February of 2008 looked pretty much unchanged from a year prior, March increased by 2 percent, April by 5 percent, May by 3 percent, and June by 5.5 percent.

All in all, first-half 2008 high-risk resets will run higher than a year earlier, but only very mildly, with the increase skewed towards the later months. According to the foreclosure study's proposed timeline, then, we can expect reset-driven foreclosures to be slightly higher in late 2008 than they were in late 2007.

read more at voiceofsandiego.org

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Submitted by Fearful on February 6, 2008 - 11:05pm.

A rising reset rate is just one element driving rising foreclosures. Fuel to the fire, if you will.

Dropping property values increases the foreclosure rate simply by the "walkaway" effect.

And rising foreclosure rates drop property values - feeding back to further raise foreclosure rates.

I wonder if there is any good way to model the overall situation. Or is the whole thing so complicated that the only way to model it is on a macro scale?

In any event, foreclosures are certainly a leading indicator of declining prices, as Rich so helpfully pointed out in the very beginning.

Submitted by gdcox on February 7, 2008 - 12:13am.

Graham
Mr Fearful. Of course that vicious cycle is happening as Rich has educated us to. The sale to default ratio below a certain level forces prices down until the ratio rises above that critical level. Bet the sales to foreclosure ratio is way high in La Jolla !

The macro economists unfortunately have not got their act together on house prices. Like the ratings agency modelers, any model they do have was not re-engineered as the new kinds of mortgages and came in.
As an ex-macro economist the price /foreclosure does my head in because is so interactive: its feeds on itself.

My only tip to modelers is to look at rental yields. There must come a point where even in bad foreclosure areas , the rental yield becomes so attractive that investors move in ( perhaps when the re-sets peak and fall away) provided employment doesn't fall off a cliff.

Submitted by robson on February 7, 2008 - 12:35am.

Yes exactly. There is a point where it becomes profitable to own and rent out a house even if it is falling in value. This is when your profit margin exceeds the loss from house price decline. Of course the exact dollar figure of this point depends on the rate of decline (real or expected). Thus, current value, mortgage rate, rate of change in value, and rent are all variables. Of course all these variables are composed of/affected by other variables, but I see this as the basic framework.

Submitted by jpinpb on February 7, 2008 - 8:13am.

Stupid question. The interest rate has been reduced twice w/possible future reductions. Wouldn't that help loans that are going to reset? If loans are going to reset, but the interest rate is down, it wouldn't reset higher than the current interest rate, would it? I don't know the details of these loans. They seemed too risky to me and I steered way clear of them w/a cross and stake. I just was under the impression that if the current interest rate is low, that will help those w/ARMs about to reset and their payments won't jump so high. If that's the case, people will be able to handle their payments and less defaults/foreclosures that would be due.

Submitted by Bugs on February 7, 2008 - 2:34pm.

The terms of the different ARMs vary quite a bit. In general, the "reset rate" after the honeymoon is a bit higher than the original fixed rate for that borrower would have been. If you think about it, it somewhat has to be that way because the loan is structured to pay off the principal over a shorter period.

So yeah, if the fixed rates drop a lot of these ARMs will reset at a rate that's a little lower than what these borrowers were looking at a year ago. To that extent, a reset rate at 7% is better than one at 8%, but it's still going to be too much for many of these borrowers. Remember, the reason most of them went with the ARMs is because they didn't make enough money to debt service the 6% fixed rate that they could have gotten at the time.

Dropping interest rates will help the ARM situation, but I doubt it will be enough to even slow down the current rate of foreclosures, let alone reverse it.

Submitted by pencilneck on February 7, 2008 - 5:23pm.

I'd also like to add that interest rates are not dropping evenly accross the board.

Interest rates for loans that appear to be very low risk are dropping (such as loans to the goverment). And higher risk loans may be dropping within risk groups (AA, BB etc), but at the same time many of these loans are bieng downgraded into higher risk categories.

I don't know what the ultimate outcome will be, but I don't imagine interest rates on high-risk loans will come down too far.

Submitted by davegnyc on February 8, 2008 - 3:03am.

My loan is tied to Libor and is resetting in March. These last to interest rate drops will help a lot as it will now reset to 5.25 instead of about 6.25%.

It is currently at 4.625, so what was going to be a big change now is something much more managable.

I would also think that buying a house has become more managable in that 4.125% conforming loans are available on 7/1 ARMs.

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