Thursday, December 01, 2005

Welcome to the gun-show...now show me your ARMs!

DAYUM!!! Mr. Greenspan should be a personal trainer...he has millions of home buyers working on their ARMs! Depending on what program you get on, your ARMs won't grow at all for a while...but then something happens....and BLAM they will really GROW!! I have seen people add 3" to their ARMs overnight!!

Yeah, too bad people's fascination with ARMs isn't in the fitness realm of things....it is in the financial.

Well, at least I'm here to "pump you up" with the real deal of what is going on out there...

Depending on where you are in the country, and whose numbers you use, ARMs (adjustible rate mortgages) are making up a staggering percentage of todays loan production. I have seen some statistics that say over 70% of the loans in California are ARMs...and many of those are interest only and option-ARMs (see my long post about them further down...or in the archives).

So what does this mean??? Here, I'll show you. Let's take the ever popular 2/28 loan that millions of "subprime", "alt-a", "non-conforming" borrowers have jumped into the past few years. Most of these have a 1.5% annual cap on the rate increases, and the index is usually the 6-month LIBOR plus the margin.

Let's just use a $300,000 loan amount as an example...and let's say the bwr got the loan a year or so ago when rates were "smokin".

$300,000 at 5.25% I/O 2/28 ARM

Payments for 24 months = (300,000 x .0525) / 12 = $ 1,312.50 a month

Now lets look at those payments when they adjust. Not only do the payments adjust, but you have to start paying the PRINCIPAL off as well (unless you refi/sell/foreclose). Let's say the rate jumps to 6.5% (could be higher) and NOW you have to amortize over the next 28 years because you didn't pay any principal during the 2 year I/O period.

Now, I'll compute the payment from my old-school HP 12c calculator...if you are smiling...you know what I'm talking about...you love'em or hate'em!

Payments when it adjusts = $ 1,941.05 a month

So the payment JUMPS $624.50 in one month!

NOW, let's assume that when you "qualified" for the loan, you met the 50% DTI (debt to income ratio). Now that your payment jumped 48% in one month, what kind of dent does that put into your cash flow?

But wait...what if you happened to have gone STATED to meet the 50% DTI requirement because you didn't make enough money to qualify for even the I/O payment??? Now what is your DTI??

I have no idea....because I don't know how much you lied your a@@ off to get the loan in the first place!

Well, I think you get my point. Now multiply this scenario by the tens of thousands. Sure, some will have sold, refi'd, or otherwise could have afforded the house in the first place...but is there any chance that maybe a few people cannot handle a $600 jump in their mortgage payments?!?!?!

Keep in mind...I only used a 300k loan amount. I see plenty of people doing this on loans from 500k to 900k and above.

Multiply the pain accordingly...

20 Comments:

Blogger ferisco said...

classic pic! that makes my day.

There was an article in the WSJ on 11/29 - "Ms. Andrews says she thought the 1.95% rate on the loan was fixed for five years. But two months after obtaining the mortgage, the couple received a statement showing that their interest rate had jumped to 4.375%...."

What is the deal with that? How many sheople make that mistake?

The article (bugmenot's login didn't work) also has some nice graphs.

12/01/2005 4:01 PM  
Blogger SoCalMtgGuy said...

Thanks Ferisco...

I did a long post about the option arm. It should either be down the side...or in the november archives.

Thanks for stopping by! ...and keep checking back!

12/01/2005 4:11 PM  
Blogger SoCalMtgGuy said...

yeah, bug-me-not does NOT work on subscription or pay sites.

only "free" sites that asky ou to register.

12/01/2005 4:12 PM  
Blogger sf_engineer said...

specific to the SF bay area, i believe there are two types of i/o borrowers...1) the type you outlined..obviously maxed out on current monthly payments, probably headed for bankrupcty when higher rates hit and 2) more affluent buyers who probably could have afforded a tradition mortgage, but don't want to "scimp" on lifestyle.
Many of my friends who have bought in San Francisco in the last few years have I/O loans (i was actually shocked to learn this). I can guess at their income and know what they paid. They still take 2 vacations a year (Europe, Thailand, you know the works), buy the latest ipod when it comes out, they all have the latest $1500 SLR digital cameras. $200 dinners are no big deal. You get the picture.

They'll probably be able to avoid foreclosure, but man they're going to be whining nonstop about how that can't afford "anything" anymore. Even though they are my friends, I'm going to feel a lot less sorry for them than the single mother earning 38K/yr.

12/01/2005 5:21 PM  
Blogger Sensible Lender said...

Everything said here about the 2/28 loans is true. Since these are the most common loan used for 100% financing, there is the potiential for big problems if prices level. If prices drop, it will be a disaster. People will not make payments they cannot afford when they have no equity.

12/01/2005 5:23 PM  
Blogger SoCalMtgGuy said...

SF Engineer...

I agree with you. I/O was intended for sophisticated bwrs with a financial game plan. Just because you have money, doesn't mean you spend it wisely.

The problem is that these people are NOT paying down any principle. Eventually, they will have to start paying it down...or sell. WHich is all well and good IF things keep going up.

I understand the reasoning...why pay a meager amount of principle when my property is going up 10k a month. You only pay about 1% of principle during the first year of having a mortgage. That is 10k on a million dollar home. Why pay it down, when it keeps screaming up?!?

Only time will tell...but eventually the FUNDAMENTALS will come back into play.

12/01/2005 9:56 PM  
Blogger SoCalMtgGuy said...

Sensible lender...

Thanks for backing me up. I have received a few e-mails from realtors and brokers that agree with me...but it is good for other people to see posters that can vouch that I'm not making this stuff up.

12/01/2005 9:57 PM  
Anonymous Anonymous said...

My brother in law worked at Fannie Mae when they came out with the I/O loan. It was originally intended for the business person who was getting moved every few years and felt locked out of buying into housing due to the high transaction costs. This was a way to trim costs by backending principal payments.



The current I/O borrowers from what socalmtguy are not what was intended. They are not sophisticated and my guess is the only time they will be moving is when they get foreclosed on soon after principal payments set in.

Metroplexual

12/02/2005 5:36 AM  
Blogger Subsonic22 said...

I have seen loans for other loan officers who insist on getting their borrowers IO loans. The whole plan is to pay IO, then flip the property in a year or so. Always 100% financing, always stated or no ratio, no doc, and always with seller financing. After all, we all know FL properties appreciate in value, why pay the mortgage company principal when you can rent it and own it at the same time. This way, instead of paying the mortgage company principal, it's money you can use for "investments".

The scary part is these investors never take into account no being able to rent out, property values stabilizing, and of course when it's time to pay the piper when the ARM starts to reset and when the mortgage company actually wants to see the principal repaid. I can't see how people are going to actually repay this debt other than having some sucker buy their homes from them.

12/02/2005 4:13 PM  
Blogger bubble skeptic said...

What is the typical fee that is paid for the 2/28 subprime ARM?

Thanks for the site.

12/05/2005 9:32 PM  
Blogger SoCalMtgGuy said...

bubble skeptic...

That all depends on the broker. Most lender fees are in the 800-1200 range, that is in addition to any points/fees the broker charges.

In the past 2-3 years, brokers were pretty much getting a minimum of 1pt on the back, if not 1.5, 2, or 3. All depends on the situation, and what they could "get away with" charging.

Just remember, in CA, the entire cost of the loan cannot exceed 6% of the loan (title, escrow, lender, points, fees, etc.)

Most brokers want to charge 3000-5000 minimum per loan (all depends on the loan amount as well). You will charge more for a 700k loan than a 120k loan.

I hope this helps somewhat.

12/05/2005 11:41 PM  
Blogger bubble skeptic said...

Yes, very helpful. Do most borrowers just roll these fees into their new loan, so that their principal balance is just increased by these fees? I'm trying to understand how deep a hole borrowers are digging for themselves. Thanks again for the site. Pretty exciting to have you chronicle in real time the greatest mortgage finance bubble in U.S. history!

12/06/2005 11:59 PM  
Blogger SoCalMtgGuy said...

bubble skeptic

Yes, most borrowers just "roll" the fees into the loan. That way they pay nothing out of pocket, and don't have a mortgage payment (if they play it right) for a month or two. They are still acruing interest, but they don't have an acutual payment due.

12/07/2005 9:38 AM  
Blogger Peter P said...

Now, I'll compute the payment from my old-school HP 12c calculator...if you are smiling...you know what I'm talking about...you love'em or hate'em!

I love them!!!

1/27/2006 11:31 AM  
Blogger Peter P said...

Also, pulling out a 12C in front of a realtor(tm) usually makes him tone down on the misinformation.

1/27/2006 11:32 AM  
Anonymous Anonymous said...

There is a valid use for I/O loans and ARMS. My perfect example:
I refinanced my 7% loan to 3.25%. Cut my mortgage payment in half I then stuck that cash in CDs and Savings accounts earning 4.5%+. At the end of 2007, I will get hit with an adjustment but guess what.....I have the cash to pay off the mortgage or take an option on another ARM if it's at a low enough rate.

2/15/2006 8:59 AM  
Anonymous Anonymous said...

Another end to the bubble might come from two changes in consumer attitude. It isn't scientific but it is possible for markets incuding housing to just plain old get exausted. SUV sales are still off 30-60% even though the oil price spike is a memory. Then there are the other consumers, the buyers of MBSecs. I find it likely that they won't want any more paper at any price. This doubly worries me as we discussed earlier how lots of seemingly ordinary commercial paper is merely laundered MBSecs. wow gold opportunity! A careful analysis of what assets or supports are actually behind the loan market would probably dictate caution and lightening up on anything with exposure.

7/17/2006 11:02 PM  
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12/09/2006 7:38 AM  
Anonymous QUALITY STOCKS UNDER 4 DOLLARS said...

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1/09/2013 11:25 PM  

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