Encompass Realty Daily News

6/30/2007

Subject: There’s a flood of foreclosures coming

By: manny @ 3:47 pm

You have a 1-in-3 chance of losing your house to foreclosure if you got an adjustable-rate mortgage, or ARM, in 2004 through 2006 that had an initial teaser rate of less than 4%.

If you got a subprime ARM in that period, you started out with a higher rate, and that puts you at less risk. You have a 1-in-8 chance of losing your home.

That’s the takeaway message from a densely detailed report by Christopher Cagan, director of research and analytics for First American CoreLogic. Cagan’s study focuses on 8.4 million ARMs that were originated in 2004, 2005 and 2006. About 1.1 million of those borrowers will lose their homes in the next six to seven years because of payment shock brought on by rate resets or loan recasting, Cagan estimates.

Cagan assumes that property values will remain relatively flat from their December 2006 levels. If house prices fall – and in many markets, they already have fallen since the start of the year – foreclosures will be higher than his estimates. If house prices rise, there will be fewer foreclosures than forecast. Each 1% rise or drop in house prices will translate into a decrease or increase of roughly 70,000 in foreclosures
“These losses are (from) reset only,” Cagan says. “I do not study job loss, death, divorce, illness or fraud.” For example, the foreclosure rate is high right now in Detroit, but that has little to do with low-rate teaser loans or subprime ARMs. Job losses are driving foreclosures in the Motor City.

Pain will linger

It’s important to remember that Cagan’s estimate of 1.1 million foreclosures is forecast to occur over the next six or seven years, not all at once. He says much of the pain will be felt next year and the year after.

The “pinch year” is 2008, he says. “That is the pileup of 2/28s originated in 2006 at the peak of the market. And also, you have the 3/27s starting in 2005. Those two years are the peak market years, also very generous lending years, so you had the peak of the market, with people borrowing with nothing down or 5% down.”

When Cagan talks about the peak of the market, he’s talking about house prices. In much of the country, especially along the coasts, prices peaked in 2006. If you borrowed 100% or 95% of the home’s value in 2006, you immediately were underwater, owing more than you would get if you immediately sold your house and paid a real-estate commission.

Subprime ARMs: 2/28, 3/27

Most subprime ARMs are 2/28 mortgages, which start out with an introductory rate that lasts two years and then are adjusted every six or 12 months thereafter for the next 28 years. Subprime 3/27 mortgages have an introductory rate that lasts three years then are adjusted for each of the next 27 years.

A lot of borrowers get 2/28 and 3/27 subprime ARMs with the intention of refinancing in two, three or four years, after they have cleaned up their credit problems. This would help them get a better rate. Those who made small down payments, though, will find it difficult to impossible to refinance if their homes have lost value.

Cagan assumes that people will lose their homes if they made small or no down payments and they get caught in the payment-value vise: when their monthly house payments rise to unaffordable levels and the value of the home has dropped or even remained unchanged. Because subprime borrowers start out with relatively higher introductory rates, they won’t suffer the worst payment shock.

The biggest payment shocks will be felt by borrowers who got those low-rate introductory loans of less than 4% (and, Cagan finds, if you got a teaser rate below 4%, it probably was under 2.5% – there weren’t many between 2.5% and 4%). Their monthly payments can double quickly. About 32% of those borrowers will find themselves in the payment-value vise and will lose their homes, Cagan estimates.

This is the second year in which Cagan has estimated how many foreclosures would result from rate reset. A year ago, he forecast that almost $200 billion in foreclosures would result over the next six or seven years. He noted that this would be a problem for borrowers but not for the economy as a whole.Holden Lewis