Housing Bubble Update
John C. Dugan, Controller of the Currency, recently commented on negative amortization mortgage products.
Here are some excerpts which validate our long held position in these pages, that neither massive layoffs nor large increases in interest rates will be necessary to put a major dent in the housing bubble:
"Until recently payment option ARMS's had been provided primarily to a narrow group of very creditworthy borrowers who found differing payment options to be an attractive “cash management” tool over time.
In the last two years, however, we have seen a spike in the volume of payment-option ARMs, which are no longer largely confined to well-heeled borrowers who can clearly afford them. And as the loans become more popular, the prospect of using them to penetrate the subprime lending market cannot be far behind.
The fundamental problem with payment option ARMs, other than the growing principal balance due to negative amortization, is payment shock.
A typical payment-option mortgage of $360,000 at 6 percent can produce a monthly payment increase of nearly 50 percent in the 6th year, assuming no change in interest rates. If rates rise to just 8 percent, the payment increase when amortization begins in the 6th year, would nearly double.
Payment-option-ARM borrowers calculate that they will be able to sell their property or refinance the mortgage by year six. If real estate prices decline – and there already is evidence of softening in some markets – these borrowers could face the bleak prospect of loan balances that exceed the value of the underlying properties.
Do consumers really understand the potential consequences of the neg am feature inherent in a payment-option ARM?
Is this an appropriate product to mass market to customers who may be looking at the less than fully amortizing minimum payment as the only way to afford a larger mortgage?
Are lenders really prepared to deal with the consequences – including litigation risk – of providing such products in markets where real estate prices soften or decline, or where interest rates substantially increase? I fear the answer to all these questions may be “no.”
Incidentally, the Payment Option ARMS have been used extensively in the first tier and sub prime mortgage markets for over 2 years now. Add in a few layoffs and a small interest increase to 7 or 8 percent and its not going to be pretty.
Here are some excerpts which validate our long held position in these pages, that neither massive layoffs nor large increases in interest rates will be necessary to put a major dent in the housing bubble:
"Until recently payment option ARMS's had been provided primarily to a narrow group of very creditworthy borrowers who found differing payment options to be an attractive “cash management” tool over time.
In the last two years, however, we have seen a spike in the volume of payment-option ARMs, which are no longer largely confined to well-heeled borrowers who can clearly afford them. And as the loans become more popular, the prospect of using them to penetrate the subprime lending market cannot be far behind.
The fundamental problem with payment option ARMs, other than the growing principal balance due to negative amortization, is payment shock.
A typical payment-option mortgage of $360,000 at 6 percent can produce a monthly payment increase of nearly 50 percent in the 6th year, assuming no change in interest rates. If rates rise to just 8 percent, the payment increase when amortization begins in the 6th year, would nearly double.
Payment-option-ARM borrowers calculate that they will be able to sell their property or refinance the mortgage by year six. If real estate prices decline – and there already is evidence of softening in some markets – these borrowers could face the bleak prospect of loan balances that exceed the value of the underlying properties.
Do consumers really understand the potential consequences of the neg am feature inherent in a payment-option ARM?
Is this an appropriate product to mass market to customers who may be looking at the less than fully amortizing minimum payment as the only way to afford a larger mortgage?
Are lenders really prepared to deal with the consequences – including litigation risk – of providing such products in markets where real estate prices soften or decline, or where interest rates substantially increase? I fear the answer to all these questions may be “no.”
Incidentally, the Payment Option ARMS have been used extensively in the first tier and sub prime mortgage markets for over 2 years now. Add in a few layoffs and a small interest increase to 7 or 8 percent and its not going to be pretty.
Comments