Friday, September 01, 2006

The American Nightmare

Fantastic piece from BusinessWeek, the cover story of the September 11th edition:

Nightmare Mortgages

They promise the American Dream: A home of your own -- with ultra-low rates and payments anyone can afford. Now, the trap has sprung

For cash-strapped homeowners, it was a pitch they couldn't refuse: Refinance your mortgage at a bargain rate and cut your payments in half. New home buyers, stretching to afford something in a super-heated market, didn't even need to produce documentation, much less a downpayment.

Those who took the bait are in for a nasty surprise. While many Americans have started to worry about falling home prices, borrowers who jumped into so-called option ARM loans have another, more urgent problem: payments that are about to skyrocket.

The option adjustable rate mortgage (ARM) might be the riskiest and most complicated home loan product ever created. With its temptingly low minimum payments, the option ARM brought a whole new group of buyers into the housing market, extending the boom longer than it could have otherwise lasted, especially in the hottest markets. Suddenly, almost anyone could afford a home -- or so they thought. The option ARM's low payments are only temporary. And the less a borrower chooses to pay now, the more is tacked onto the balance.

The bill is coming due. Many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules -- often to the astonishment of people who thought the low installments were fixed for at least five years. And because home prices have leveled off, borrowers can't count on rising equity to bail them out. What's more, steep penalties prevent them from refinancing. The most diligent home buyers asked enough questions to know that option ARMs can be fraught with risk. But others, caught up in real estate mania, ignored or failed to appreciate the risk.

56 Comments:

Blogger Mr. Oliver said...

Wow, Grim. That is a must read. Thank you.

9/01/2006 06:20:00 AM  
Anonymous Anonymous said...

SAS,

Are you out there? willO il go up $30 today, its labor day weekend, we don't see $100????

JM

9/01/2006 06:29:00 AM  
Blogger thatbigwindow said...

Too bad this article didn't come out before everyone started going mainstream with these mortgages.

9/01/2006 07:28:00 AM  
Anonymous Anonymous said...

A little to late for these DUMMIES! The ethical RE industry of course explained clearly the risks of these loans.

Alot of sleepless nights for many Dummies in the next 2 years. A financial disaster is heading their way.

Bleed'em Dry.

9/01/2006 07:52:00 AM  
Anonymous gary said...

comedy at it's best:

http://articles.moneycentral.msn.com/Investing/CNBC/TVReports/CyberspaceForetellHousingRebound.aspx

9/01/2006 08:05:00 AM  
Blogger grim said...

I can say for sure there has been an incredible increase in Google traffic to this site based on searches for:

New Jersey Housing Bubble
North Jersey Housing Bubble
NJ Housing Bubble
NJ Real Estate Bubble
etc

9/01/2006 08:11:00 AM  
Anonymous Anonymous said...

A state of Depression for these Option ARM Dummies.

Just drive by some of those houses that were bloated in price and sold in last 3 years. watch for signs of distress.

hehehehe

Babababab

BOOOOOOOOOOYAAAAAAAAAA

Bob

9/01/2006 08:12:00 AM  
Anonymous Anonymous said...

do you see it!

TSUNAMI WAVE 2 IN THE DISTANCE....OOOHH YOU CAN'T SEE IT YET MONEY GRUBBIN"IT'S NOT 2005" SELLERS?...YOU WILL SOON ENOUGH IN ABOUT 3-6 MONTHS. there will be no doubt then what's happening....

pop pop fizz fizz oh where is my home equiteeeee......

Bababababa

9/01/2006 08:16:00 AM  
Blogger RentinginNJ said...

Washington Mutual alone holds $7.04 billion in option ARMs in NY and NJ; that’s about 10% of their O-ARM portfolio.

Also interesting to note, in 2003, 1% of WaMu’s O-ARM’s resulted in negative amortization (in other words, 1% of borrowers made the minimum payment). By 2005, this number jumped to 50%. This number also doesn’t account for borrowers just paying the interest

9/01/2006 08:18:00 AM  
Anonymous Anonymous said...

Also interesting to note, in 2003, 1% of WaMu’s O-ARM’s resulted in negative amortization (in other words, 1% of borrowers made the minimum payment). By 2005, this number jumped to 50%. This number also doesn’t account for borrowers just paying the interest


NICE Fact.

How do you spin this Greedy starving "No Commish this month" realtors?

It's not a one-way street when it comes to markets. They go up and they go DOWN! The housing market is in DOWN mode for several years to correct the insnaity of the past 3-5 years.

Getting a little sore and cranky lately starving No commish this month realtors?

Just watch the realtor harassment levels. When you are being attacked and called every week by a starving no commish this month realtor, You know things are really brutal. Well financed buyers may help but with the help are starving realtors slapping some sense into these "it's not 2005" greedy grubbing sellers.

Babababa

9/01/2006 08:23:00 AM  
Anonymous Anonymous said...

grim said...
"I can say for sure there has been an incredible increase in Google traffic to this site based on searches for:"

It's all indicative of a market that stopped on a dime and now the trend starts its reversal. It would be interesting to see a chart in the future, comparing the # of hits on this site from 1-2 years ago to some date in the future.

The article states that these loans, IO's may be the riskiest home loan product EVER created. No suprise here. Combine this with irrational,delusional,comatose sellers and its a recipe for disaster.

BC Bob

9/01/2006 08:23:00 AM  
Anonymous Anonymous said...

Too bad this article didn't come out before everyone started going mainstream with these mortgages.

I'd be willing to bet that at least half of the people reading this blog knew about the dangers of option ARMs in 2005.

The information was out there; the people who signed up for them didn't do their homework, or didn't want to know.

There is no free lunch.

jw

9/01/2006 08:24:00 AM  
Anonymous Anonymous said...

"There is no free lunch."

Or

"if it sounds to good to be true it is"

The dummies are lined up for slaughter....Just take a number and wait your turn...

Bababababa

Booooooooooyaaaaaaaaaa

Bob

9/01/2006 08:26:00 AM  
Blogger grim said...

Heard a new Realtor Ethics (tm) commercial on Bloomberg AM this morning.

Was a Realtor (tm) talking about how she sends inner city kids to camps over the summer.

They've stepped up the ethics propoganda to a new level.

grim

9/01/2006 08:26:00 AM  
Anonymous Anonymous said...

grim.

shameless is the word.

come on post those articles about
our gov.

shameless is the word.

9/01/2006 08:32:00 AM  
Anonymous UnRealtor said...

Great cover photo as well, should beat even the most dense over the head.

But sadly, the media is 2-3 years late to the party and their recent epiphany to start reporting objectively on the housing bubble is too late -- millions of "owners" are already screwed.

9/01/2006 08:39:00 AM  
Blogger Clare said...

I can only imagine how the people who gave up the 5.1% and 5.25% fixed mortgage rates feel. What were they thinking? I guess they couldn't be bothered to try to understand the deal. I refuse to believe that it is too complicated for them to understand, I think they prefer not to give it thought. I see it all the time with my high school students. They do not want to think about the problem and understand what they are solving. They want a quick step by step (cookbook type) formula for if a problem looks like this, punch this into the calculator and get the answer. Unfortunately for the people in this article they will have to live with the ramifications of not analyzing/understanding the contract and thinking about the worst case scenario. I feel bad that they had to learn this lesson the hard way but I bet they will examine all future contracts a bit more thoroughly.

9/01/2006 08:42:00 AM  
Blogger grim said...

If the media had come forward earlier they would have been labelled pessimists and "chicken littles", much like the bubble bloggers were.

Even worse, they would have been labeled anti-something-or-other for speaking out against loans that offer affordability and homeownership to those who otherwise wouldn't be able to.

This is the typical argument heard when any talk of regulation of these loans comes up.

grim

9/01/2006 08:44:00 AM  
Blogger Clare said...

I should have said worse case scenario good thing I teach math and not English

9/01/2006 08:44:00 AM  
Anonymous Anonymous said...

The American Nightmare === No personal responsibility for ones self.

Most spend reckelessly on $300 jeans, $3,000 TV's and $50,000 SUV's...

We live vicariously thru sports teams where a ticket costs $50 and a bottle of water costs $5.00. A nice diversion from ones meaningless life which is nothing more than 'buying things'.

Then instead of getting a higher paying job, we max out on credit cards to buy the latest fashions, spend a few thousand every month on clothing and another few hundred on dining out (and believe PF chang & Cheesecake factory is fine dining worth the 1 + hour wait), and buy the largest house & most expensive car we can qualify for by someone, some lender (not afford but qualify to buy)

9/01/2006 08:54:00 AM  
Anonymous Anonymous said...

Business Week has been the biggest cheerleader of the "US Consumer" for the past 5 years and the "robust" job market.

Now they are publishing this crap. What f**cking hypocrites to say the least.

9/01/2006 08:57:00 AM  
Blogger Jpatrick said...

Not long ago, I sat down at a closing where the buyer got a "zero down" deal. Of course the mortgage was an ARM, but it didn't stop there. Oh, no. There was also a 3% PREPAYMENT PENALTY.

That property now belongs to the lender.

9/01/2006 08:59:00 AM  
Blogger Richie said...

A nightmare to some, the "American Dream" to others..

I admit, when I was younger I used to spend frivolously. Concerts, clothes, toys, etc. Never to the point where I was carrying a balance, though.

If I had the chance to do it again, would I have changed my habits? Probably not. I had fun, I enjoyed it, and I have no regrets.

Best of all, I spent within my means and carried no debt.

-Richie

9/01/2006 08:59:00 AM  
Anonymous UnRealtor said...

Very nice:

"Gordon Burger is among the first wave of option ARM casualties. The 42-year-old police officer from a suburb of Sacramento, Calif., is stuck in a new mortgage that's making him poorer by the month. Burger, a solid earner with clean credit, has bought and sold several houses in the past. In February he got a flyer from a broker advertising an interest rate of 2.2%. It was an unbeatable opportunity, he thought. If he refinanced the mortgage on his $500,000 home into an option ARM, he could save $14,000 in interest payments over three years. Burger quickly pulled the trigger, switching out of his 5.1% fixed-rate loan. "The payment schedule looked like what we talked about, so I just started signing away," says Burger. He didn't read the fine print.

After two months Burger noticed that the minimum payment of $1,697 was actually adding $1,000 to his balance every month. "I'm not making any ground on this house; it's a loss every month," he says. He says he was told by his lender, Minneapolis-based Homecoming Financial, a unit of Residential Capital, the nation's fifth-largest mortgage shop, that he'd have to pay more than $10,000 in prepayment penalties to refinance out of the loan."

9/01/2006 09:04:00 AM  
Anonymous UnRealtor said...

More:

"Up to 80% of all option ARM borrowers make only the minimum payment each month, according to Fitch Ratings. The rest of the money gets added to the balance of the mortgage, a situation known as negative amortization. And once balances grow to a certain amount, the loans automatically reset at far higher payments. Most of these borrowers aren't paying down their loans; they're underpaying them up."

9/01/2006 09:07:00 AM  
Anonymous Anonymous said...

{{{I admit, when I was younger I used to spend frivolously. Concerts, clothes, toys, etc. Never to the point where I was carrying a balance, though.

If I had the chance to do it again, would I have changed my habits? Probably not. I had fun, I enjoyed it, and I have no regrets.

Best of all, I spent within my means and carried no debt.}}}

That is like saying you smoke pot but 'don't inhale'..

Unless you make over $300,000, it is impossible to spend like that unless you go into 5 figures of credit card debt. And of course, you need the thousand dollar outfits for the occasion.

I make $75,000 a year and feel like I am living in poverty. Like everyone else my age and at my income, I am in credit card debt and trying to get a higher paying job to pay it off. Thank god my rent is still under $900 a month or I would need to move out of this region.

9/01/2006 09:12:00 AM  
Blogger thatbigwindow said...

$75,000 and living in poverty? I make significantly less than that and am quite comfortable. But then again, I do not have any cable TV, internet connection at home, credit card debt, I wear old clothes, etc

I guess some may say I live in "poverty" but I am happy with living without excess. I go out to eat every weekend though...that is my one vice

9/01/2006 09:27:00 AM  
Blogger lisoosh said...

"There was plenty more going on behind the scenes they didn't know about, either: that their broker was paid more to sell option ARMs than other mortgages; that their lender is allowed to claim the full monthly payment as revenue on its books even when borrowers choose to pay much less;"

Wait for the lawsuits and finger pointing to start.

9/01/2006 09:32:00 AM  
Blogger Richie said...

Unless you make over $300,000, it is impossible to spend like that unless you go into 5 figures of credit card debt. And of course, you need the thousand dollar outfits for the occasion.

I didn't even say how much I spent, so how can you make any assumptions?!

-Richie

9/01/2006 09:50:00 AM  
Anonymous UnRealtor said...

In the related "Worst Practices" article:

Consider Greg, a single father earning about $45,000 a year as a baker in San Diego who asked BusinessWeek not to use his last name. A decade ago a bank might have given him a mortgage for about $100,000, or 2.5 times his income, the rule of thumb. Yet he's on the hook for about $940,000, or nearly 21 times his pay, with two loans on two houses from Countrywide and Accredited Home Services. (Neither would comment on an individual case.) Says his bankruptcy attorney, Ray Schimmel: "He got those loans in about a year. How crazy is that?"

Greg started by borrowing $4,500 from his 401(k) -- not even enough to the cover closing costs. When he couldn't make payments on his first house, he rented it out and moved into a utility closet. Then he tried to get out of trouble by buying another house and flipping it. No dice. To cover his three mortgage payments, he has racked up $55,000 in credit card debt. Both houses are for sale, but in a slumping California market Greg will be lucky to break even.


http://tinyurl.com/zdejr



Break even? Hello? He's going to lose, badly.

9/01/2006 09:50:00 AM  
Blogger chicagofinance said...

The more I see, the more that I reserve judgement.

People are the same as they ever were.

If exotic loans existed 30 years ago they would have been used.

The REAL tragedy is that the financial conventions of days gone by, such as 30-year fixed amortizing loans, absence of car leases, and ubiquitous employer pensions, represented a method of passive forced savings and forced risk mitigation.

The forced methods of prudence have been eliminated, and now individulas have the means to satisfy their urges.

There is nothing to blame but innovation.

There is no free lunch.

Don't be angry about.

Observe the human condition, profit from it should that be your motive.

chicago

9/01/2006 09:50:00 AM  
Anonymous UnRealtor said...

Recent NJ foreclosure history, broken down by county:

http://tinyurl.com/embeu

9/01/2006 09:52:00 AM  
Anonymous Anonymous said...

US Show & Tell Society sucking wind. It must suck waking up to just to "Make the dooooughnuts" and pay the monthly debt slave payments. Debt jugglers.

Unfortunately many Show & tellers get caught up in this phoney game. In the end they lose.

Lots and lots of sleepless nights ahead for Debt jugglers.

As for $300 jeans, many of these show & tellers secretly scoot into the brand name discount establishments cuz they are tapped out and can't afford the $300 jeans.

Babababa

9/01/2006 09:55:00 AM  
Anonymous UnRealtor said...

"I make $75,000 a year and feel like I am living in poverty."


The problem isn't your salary. You shouldn't be in debt, unless you're living well beyond your means.

Rent @ $12K a year
Used car @ $10,000 (one-time payment)
Food at $3,000 a year


What are you spending all your money on, that the credit card debt is accumulating?

9/01/2006 09:56:00 AM  
Anonymous UnRealtor said...

The option ARM is "like the neutron bomb," says George McCarthy, a housing economist at New York's Ford Foundation. "It's going to kill all the people but leave the houses standing."


Boom!

9/01/2006 10:01:00 AM  
Anonymous Anonymous said...

KABOOOOOM!

IS THIS WHAT YOU WANT TO HEAR FOR THE REST OF YOUR LIFE?

GOTTTAAA MAKE THE DOOOOOOUGHNUTS!

9/01/2006 10:03:00 AM  
Blogger grim said...

I wonder if the foreclosure history for Hudson is correct, something doesn't seem right there, a jump from what looks like an average foreclosure rate of 50/quarter to 785 in the most recent quarter?

grim

9/01/2006 10:07:00 AM  
Anonymous Anonymous said...

confused on ARM reset -
If a buyer got a 5/1 ARM at 5% and it's supposed to reset at the current rates, is he really in trouble?
aren't rates tied to the 10-year yields which have fallen the last few weeks. won't mortgages reset to about 1% over the 10?
what would it reset to if it is to reset today?

SEPY

9/01/2006 10:13:00 AM  
Anonymous Anonymous said...

I also question the BW chart -- I've studied it before and I am fairly sure they had the numbers wrong for CT (which is completely absent from the current chart) Has anyone queried the editors?

9/01/2006 10:16:00 AM  
Blogger chicagofinance said...

UnRealtor said...
"I make $75,000 a year and feel like I am living in poverty."
The problem isn't your salary. You shouldn't be in debt, unless you're living well beyond your means.
Rent @ $12K a year
Used car @ $10,000 (one-time payment)
Food at $3,000 a year
What are you spending all your money on, that the credit card debt is accumulating?
9/01/2006 10:56:45 AM

Possibilities
1. Mega high speed internet
2. Shrink

9/01/2006 10:19:00 AM  
Blogger grim said...

SEPY,

It depends on the index the ARM is tied to.

http://www.hsh.com/index.html

grim

9/01/2006 10:24:00 AM  
Anonymous buyingthefarm said...

I just opened a 13 month cd at WaMu at 6.00% APY for $120,000 while we wait for the market to adjust. Anything to worry about from banks holding ARM's? -- farmer in central NJ

9/01/2006 10:32:00 AM  
Anonymous Anonymous said...

We all knew that this was an accident waiting to happen. However, I did not know the actual #'s. The article points out that more than 20% of option ARM loans in 2004 and 2005 are upside down .If home prices fall 10%, that number would double. What the hell would happen with a 20, 30% decline??? For all those anons that state it is different this time, you're damn right it is different. I honestly feel, after reading the actual #'s, that I may be too conservative in my downside expectations.

It seems to me that this is just one big carry trade, similar in ways to LTCM. The accounting procedures, booking the phanthom value rather than real value seems very enronic to me. I realize that is how it is done. However, it's just another potential financial time bomb.

BC Bob

9/01/2006 11:01:00 AM  
Anonymous Anonymous said...

JM

9/01/2006 07:29:11 AM

Just curious, are you happy with $70 oil????

BC Bob

9/01/2006 11:04:00 AM  
Blogger chicagofinance said...

Bergs:

It's not a binary equation. The financial carnage in business will be shades of gray. The binary is homedwellers. Have house or lose house. OK or soup kitchen.

chicago

9/01/2006 11:26:00 AM  
Blogger chicagofinance said...

Bergs:

Also, the economy in the U.S. is the most resilient and adaptable one on the planet.

Don't be against us. We won't be knocked out.

chicago

9/01/2006 11:28:00 AM  
Blogger thatbigwindow said...

Oh, almost forgot to tell my bubble-blogger friends: I met an accountant at a party a few weeks ago. He has all of his money tied up in Florida and NJ real estate. He said that he doesn't have any positive cash flow, so he does not contribute to his 401k or retirement. He thinks that he will retire quite well off with his real estate investments. Sad thing is, he is an accountant. I wouldn't want him doing my taxes!

9/01/2006 11:44:00 AM  
Blogger Richard said...

as my dad used to say, you have to fall down by yourself. hopefully those burned by their appetite for risk or ignorance will be able to learn something and be better for it.

9/01/2006 11:47:00 AM  
Anonymous Anonymous said...

Lishoosh

You are on the money. I am an attorney and already see the suits being filed against lenders for being preditory and discrimonatory. My fear is that these buyers will not end up learning a lesson. They will be bailed out.

9/01/2006 11:55:00 AM  
Anonymous Anonymous said...

JM,

yup, I am here. yes, I am very surprized crude ain't $100/barrel right now. So, yes...I shall eat crow today ;)

I think there wasn't any hurricanes this year, and we are tapping into the oil reserves now more than ever. Not a good thing.

I still say we will hit $100 soon. The exact time point is hard to predict.

I think the consumer is funding gas prices with credit, so that is why things are still status quo.

We shall see.

SAS

9/01/2006 11:57:00 AM  
Anonymous Anonymous said...

The article points out that more than 20% of option ARM loans in 2004 and 2005 are upside down .

Can anyone point me to the total number of homeowners with option ARM loans? Not the totals for purchases in 2003-2006, but the the total overall?

35% of American homeowners have no mortgage debt. Another 50% have traditional fixed-rate loans.

That leaves 15% with aggressive financing of some sort.

I'd just like to get a handle on the proportion of homeowners who will be affected by rate resets.

9/01/2006 12:45:00 PM  
Anonymous Anonymous said...

I don't understand how
"Many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules "

doesn't it take 5 years to reset on a 5/1? shouldn't it be 2009 - 2010?

9/01/2006 02:56:00 PM  
Anonymous Anonymous said...

thanks grim -
I checked it out and it seems most indexes are hovering around 5%. I'm just not seeing what the problem is with the fact that ARMs are starting to reset given these numbers. I doubt majority of recent buyers got 2-3% on their 3 & 5/1 ARMs.
In my example above where a buyer took out a 5/1 ARM at 5% (which I believe is what most people probably got), it seems his mortgage payments will be just about the same if it was to reset today.
I can see property taxes causing monthly payments to shoot up but certainly not the reset at the current rates.

sorry guys...hope you can help a layman out.

thanks!

SEPY

9/01/2006 03:09:00 PM  
Blogger Math, like gravity, is law. said...

Anonymous said...
JM,

yup, I am here. yes, I am very surprized crude ain't $100/barrel right now. So, yes...I shall eat crow today ;)

I think there wasn't any hurricanes this year, and we are tapping into the oil reserves now more than ever. Not a good thing.

I still say we will hit $100 soon. The exact time point is hard to predict.

I think the consumer is funding gas prices with credit, so that is why things are still status quo.

We shall see.

SAS

9/01/2006 12:57:10 PM

SAS, Ain't gonna happen.

9/01/2006 04:48:00 PM  
Anonymous Anonymous said...

The "Reset" they're talking about in the article is, I believe, the Reset that takes place when the borrower has only made the minimum payment. Under the Terms they signed up for, making the minimum payment for X Months allows the Lender to reset to a higher rate.

9/01/2006 07:18:00 PM  
Blogger Jpatrick said...

My ARMS are free. I've sold all my real estate.

9/01/2006 08:17:00 PM  

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