Capacity crunch, round two...coming soon to a neighborhood near you

06.18.09
By John Ulzheimer

According to the latest USA TODAY/IHS Global Insight index, the recession will end later this year and will be followed by some sort of recovery. Their results offer some much needed good news after eighteen months of bank failures, market losses, job losses, foreclosures and Ponzi schemes. And while that reads well in the press, a serious mortgage problem still remains.  

There are millions of adjustable rate mortgages (ARMs) that will begin to reset over the next twenty-four months. Many of these are what are referred to as Option ARM loans. “An Option ARM is a hybrid adjustable loan that often results in negative amortization,” according to Amir Fathi, a mortgage lender and co-founder of LoanModDVD, a do-it-yourself mortgage loan modification kit. “We’re not out of the woods yet, not by a long shot.”

Many of these adjustable rate loans were used by prime borrowers to buy or build expensive houses in expensive neighborhoods in expensive cities. These so-called McMansions have huge price tags but affordable monthly payments – for now. Once the interest rates and terms adjust, many could easily see their monthly mortgage payment balloon by several hundred or even several thousands of dollars. At this point you will not have a second round of “credit crunch” defaults, which was an incorrect way to label the current mortgage meltdown. What you will have, however, is a second round of “capacity crunch” defaults, where homeowners’ income is no longer sufficient.  

These homeowners are finding it difficult or impossible to refinance because they have negative equity in their home. And the loan amount is far too high to depend on an FHA alternative. Their loans are not jumbo but super jumbo. And the only way a lender will be willing to take on a refinance of one of these huge loans will be for the homeowner to buy down the balance so that it, in fact, has a sufficient amount of positive equity to provide lenders with assurance that their investments are safe. This is a very expensive proposition that could cost hundreds of thousands of dollars (which not many people have sitting around collecting dust, or 1 percent interest in a savings account).

So while you’re reading articles about how the future is looking better and the economy is recovering, please keep one thing in mind. These studies are done at a very macro level. This means the researchers are looking at large swaths of data and drawing their own conclusions for a very large number of consumer households over large geographies. At the end of the day I’m certain it’s your one household’s economy that you’re most concerned with.

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There are millions of adjustable rate mortgages that will begin to reset over the next twenty-four months.