There has been a delay in the doomsday scenario for option ARMs (adjustable rate mortgages) recently because interest rates they are tied to have dropped, so loans are going to take longer to reach their cap and will not be recast to a higher a rate. Now the future looks worse with interest rates are rising again.
But Barclays Capital, which expects 81 percent of the option ARMs originated in 2007 to default and projects that banks will lose $112 billion on option ARMs written from 2005 to 2007.
First American CoreLogic anticipates 600,000 option ARMS to reset within four years.
Option ARMs, which lenders stopped offering last year, gave borrowers four payment options: less than the interest, which increases the balance every month; just the interest; the equivalent of a 30-year fixed-rate mortgage; and the equivalent of a 15-year fixed.
"Everyone's been focused on subprime, but we're more concerned about this," said Todd Jadlos, managing director of LPS Applied Analytics, which analyzes data for the financial industry. "By the time subprime defaults had increased 200 percent, in June and July of 2007, option ARMs had gone up 400 percent. People just didn't notice because the overall numbers weren't as high."
"This was a loan meant for sophisticated investors, or people who expected their cash flow to increase over time," said Elena Warshawsky, ...
Adjustable Mortgages Loom as Threat to Housing Recovery