If the previous year of record foreclosure rates, falling home values, a declining stock market, and continuing inflation have seemed like too much catastrophe for the US economy to bear, just wait. There will be no short term recovery in the housing market; in fact, foreclosures will continue to increase and property values will keep falling for at least the next year, with a second wave of foreclosures set to begin in the spring of 2009.
Now that the subprime mortgage market has collapsed, the next shoe to drop will be the Option Adjustable Rate Mortgages, a wave of which is set to adjust beginning in April 2009. These loans were originally sold to homeowners eager to cash in on rising property values and who wanted to keep their payments as low as possible. But the steep declines in real estate markets over the past year due to the foreclosure crisis is helping to fuel a self-sustaining cycle of foreclosures, followed by property value decrease, followed by more foreclosures.
What makes the coming option ARM resets most worrying is who they were marketed to and what the “option” part of the mortgage really means. Borrowers with credit slightly better than subprime were able to qualify for these loans, but lending guidelines were almost nonexistent during the boom. What was considered “slightly better than subprime” then may be considered completely unqualified for a mortgage loan now. So the banks may find that they have a second wave of subprime borrowers struggling at the present time who will have no other option than to default when their payments adjust.
And when the payments reset based on the interest rates at the time of adjustment, and monthly mortgage payments on such loans may become instantly unmanageable for many homeowners. Option ARMs allowed homeowners to pay only a small portion of the interest on their loan every month, which may result in negative amortization. In other words, borrowers keep making monthly payments only to find out that they are falling further behind on the loan every month.
At the same time, their properties are falling in value, so they are being attacked from both sides: equity is disappearing as their monthly payment is not enough to pay off the interest, and property values are falling closer to the amount of the loan or below. This helps to accelerate how quickly homeowners find themselves underwater in a house. And few homeowners feel good about sending in a higher mortgage payment every month when they realize their equity has been completely eliminated by the loan itself and the market.
As usual, many people obtained these loans not fully understanding how they worked, why their payment was so low, and how they were able to qualify for such a seemingly great interest rate with such seemingly poor credit. Many of them may be surprised to find out that, when their interest rate adjusts, they will need to begin making payments on both the principal and interest of the loan. But even for the ones who are aware of this danger of a skyrocketing payment, selling the home is no longer an option when the market has declined so far.
It is clear already that there is an economic crisis in the housing market, which was fostered and inflated by the Federal Reserve’s cheap monetary policy and the banks’ abandonment of reasonable lending standards. And although there have already been predictions of the end of the recession that was never really a recession, looking a bit into the future seems to suggest that the foreclosure crisis and declining real estate values are only just beginning. If homeowners are able to refinance to a fixed rate or sell at a profit or break-even point, now may be the time, before it is too late.