When talking about the U.S. home market, mentioning “the other shoe to drop” was quaint about a year ago. Now we are referring only to bombs.
The latest ordnance is the option adjustable-rate mortgage, one of the many sucker loans marketed during the housing boom. Option ARMs basically gave borrowers four ways to pay back, most of them involving low initial outlays that would reset at much higher monthly amounts at a future date.
Of the $200 billion of these loans outstanding, almost $30 billion is due to reset this year and $67 billion in 2010, according to Fitch Ratings, a New York-based ratings company.
The resets inflict more trauma on the U.S. housing market. The average option ARM monthly payment will soar 63 percent — or $1,052. Although there was a slight increase in home sales in November, prices fell 18 percent from a year earlier, according to the S&P/Case-Shiller Index.
The pain continues. Since most option ARM borrowers will be unable to refinance because of lowered credit ratings or lack of home equity, many of those resets will result in more foreclosures and further depress home prices.
Ultimately, the option-ARM resets might plunge 8 million more households into foreclosure. That’s in addition to the 2.3 million facing home loss last year, says Eric Rothmann, an analyst for Zacks Investment Research in Chicago.
The shock-and-awe days of the housing crisis are far from over because of these loans and their cousins: subprime, “Alt- A” and some prime mortgages. While Barack Obama’s administration struggles to fix the banking industry, it will be difficult to directly remove these loans — and related securities — from balance sheets without triggering billions in writedowns.
The option-ARM barrage will exacerbate the housing decline in the worst-hit areas.
Homes that can’t be refinanced probably won’t be sold immediately. Assuming no government aid comes along to help these homeowners, the houses will go into foreclosure and be resold at much lower prices. That fuels what economists call a “feedback loop” of ever-lower values.
Houses that are resold are discounted at least 30 percent from the original selling prices, according to U.S. researchers John Campbell, Stefano Giglio and Parag Pathak, who studied 1.8 million transactions in Massachusetts over the past 20 years.