Payment Shock Concerns Grow as Billions in Interest Only Loans Face Recast Date

[FarCenter]

http://www.mortgagenewsdaily.com/01132010_rmbs_fitch_io_loans.asp
by Jann Swanson

Fitch Ratings warned today that billions of prime and Alt-A mortgages that were written as interest-only (IO) loans are due to recast over the next two years. $47 billion of these loans convert to fully amortizing loans in the next 12 months and a total of $80 billion in Prime and Alt-A loans and another $50 billion Subprime loans will recast by the end of 2011. These conversions will result in substantially higher monthly payments.

While IO options were written into both fixed rate (FRM) and adjustable rate mortgages (ARM), over 90 percent of the loans in each category, prime, Alt-A, and subprime, are ARMs because those offered borrowers the lowest payments and many borrowers qualified only because of these artificially low payments. In addition, 63% of Prime and Alt-A loans qualified based on less than a full documentation of income.

As MND reported, in September Fitch warned that $134 billion in Option ARMs would recast by the end of 2010. Option ARMs are mortgages that allow the borrower to choose each month among making a fully amortizing payment, an interest only payment, or a smaller payment that does not cover all of the interest. In the last case the remaining interest is added to the mortgage balance. Fitch estimated that 94 percent of Option borrowers had exercised the lowest payment option, allowing the loan to negatively amortize. These loans will recast both as fully amortizing loans and at a higher balance than the borrower qualified for.

Because interest rates have remained low, many of the IO loans due to recast will have payment increases only to the extent necessary to begin amortizing and some may actually have the payment shock mitigated by a lower interest rate. However, many Subprime loans have an interest rate floor that does not allow the rate to drop below the initial one and, in subsequent years, all borrowers will probably suffer additional payment shock as their loans go through periodic rate adjustments. Just considering the amortization component or the recast, current average payment shocks are estimated at 15%, and each 1% rise in the benchmark rates corresponds to an approximate 10% increase in payment shock.

<SNIP>http://www.mortgagenewsdaily.com/01132010_rmbs_fitch_io_loans.asp

[Ian David]

1. I read that as "loans face racist date" n/t

[Igel]

2. Yeah, it's old news worth remembering.

Still, it's not uncontroversial. See http://www.businessinsider.com/henry-blodget-the-coming-alt-a-mortgage-reset-bomb-is-a-myth-2009-8 for another view, one that I can't argue against nor accurately evaluate. It seems plausible, which is to say, :shrug:

This chart or something like it was common a year or two ago. It's hard to read in the link I gave above.

[FarCenter]

5. Thanks for the charts -- The mortgage pain won't end until mid-2012

Since it will take at least that long to work through the foreclosures on resets through the first quarter of 2012.

[Lance_Boyle]

3. How long did people really think they could go on paying interest-only (or less!)

on their loans?

Nobody should be surprised by these recasts - the dates and details are spelled out in the loan paperwork.

[cbdo2007]

4. Why would they read their paperwork? Or as the article says....why would they

even pay more than the minimum??? ha ha

I'm not happy this is happening, but really the mortgage and credit card companies have come up with an absolutely perfect business model - give American's the options to pay less and they will always take it, even if that means they will pay much, much, much more money for it in the long run.

Who does these interest only loans anyways??? Like, why on Earth would someone buy a house to NOT get any equity?

There are so many things in this story that baffle me, it's hard to even collect my thoughts. All I know is that the problems with credit cards and mortgages will never go away in the U.S. because people simply don't care what the terms of the agreement are and they don't pay attention to them at all.