The Subprime Meltdown Will Be Nothing Compared To The Prime Meltdown
James Dimon, the chairman and chief executive of JPMorgan Chase, is not optimistic about the mortgage market. He told investors that he expects the losses mortgages given to people with good or excellent credit to be “terrible.” According to the New York Times, "The first wave of Americans to default on their home mortgages appears to be cresting, but a second, far larger one is quickly building." How can this be?
The trouble stems from the "Alt-A" borrowers and Option-ARM loans. These loans were often issued to borrowers with good credit who were speculating on the housing market or who lacked the proper documentation of income to qualify for a traditional mortgage. Households with prime credit make up the bulk of the mortgage market, and delinquencies are rising fast, particularly in the Alt-A sector. The Times says Alt-A delinquencies quadrupled to 12 percent in April from a year earlier. The credit crunch is, of course, exacerbating the issue, as borrowers are finding it much more difficult to refinance or sell their homes as their monthly payments become unaffordable.
“Subprime was the tip of the iceberg,” said Thomas H. Atteberry, president of First Pacific Advisors, a investment firm in Los Angeles that trades mortgage securities. “Prime will be far bigger in its impact.
...
What will sting borrowers more than rising interest rates, analysts say, is having to pay interest and principal every month after spending several years paying only interest or sometimes even less than that. Such loan terms were popular during the boom with alt-A and prime borrowers and appeared appealing while home prices were rising and interest rates were low.But now, some borrowers could see their payments jump 50 percent or more, and they may not be able to sell their properties for as much as they owe.
Although this mortgages sound exotic, the Times says that banks carry many more of them on their books than subprime mortgages. Option-ARM mortgages will prove particularly troublesome to deal with, because its so much more likely that the borrower will owe significantly more than the property is worth. Option-ARM mortgages allow the borrower to pay little or nothing at first -- and any unpaid interest is added to the principal due on the loan. This results in a mortgage that grows over time. Eventually, when the borrower owes 10-15% more than the original loan, the payments increase rapidly.
“The wave on the prime side has lagged the wave on the subprime side,” said Rod Dubitsky, head of asset-backed research at Credit Suisse. “The reset of option ARM loans is a big event that will drive the timing of delinquencies.”
Housing Lenders Fear Bigger Wave of Loan Defaults [NYT]
(Photo: Truthaboutmortgage.com )
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Yay!
Please no Bail outs. I would like to buy a home before I'm 40. Perhaps be able to afford one of those "starter homes" they talked about in the old days.
@testsicles: Oh, of course its The Simpsons:
Homer: "And that's it right?"
Salesman: "Yup, oh then after your final monthly payment there's the CBP, or Crippling Balloon Payment."
Homer: "Yeah, but that's not for a while, right?"
Salesman: "Right!"
And I thought interest-only loans were crazy. I can't imagine a case where I would have a loan where the principal increases because I'm paying less than the interest. These people might have (had) good credit, but their money smarts makes them sub-prime in my mind. @testsicles: Simpsons did it. The one where Homer buys an SUV.
@testsicles: Ditto on the being scared silly on anything other than "30 year fixed" when I bought in 2005. And I have a finance degree.
So basically, the banks apparently have one good mortgage on the books...and it is mine.
I think the whole situation can be summed up as "people are dumb". Especially when money is involved.
@Roy Hobbs: no kidding, basically what I got was with my 30 year fixed I knew how much I would pay and with anything else, it was up to the bank. They were like, but your monthly payment will be $500 less a month for 3 years! And I'd respond but what's to stop you from charging my twice that for the remaining 27?
Question for someone who knows things: Why don't banks package and sell these loans like they do subprime?
Are they more profitable, or more stable, or what?
Also, I feel obligated to add the predictable: "So taking out a loan in which you don't have to pay down the principal is not smart? Really?"
Even people with traditional fixed rate mortgages are going to suffer. With the rising costs of oil, gas, food, etc many people who were making it work before are struggling to pay their mortgage. In the good old days if you had too much house and not enough money you could sell it and downgrade. With so many people so desperate to sell (not to mention the bank-owned properties being sold for $70-80k less than a year ago) there is no way out. It makes me so depressed, especially as someone who did everything right but will probably never get back the money we've put into this house if we have to move in the next 10 years.
I happen to be caught in the mix. Great credit, income is variable as business owners so we couldn't do full doc, and we went interest only to be able to afford Southern CA. 5 years later, just had our first adjusted month with a 53% payment increase, and the new variable rate is better than any available refi option!. So we just have to deal with it! Rates suck, prices are down to reduce our equity, our loan is a jumbo, etc. I am not crying to anyone, but I sure would like to see some reasonable ideas to get into a fixed rate. I have the "pleasure" of being squeezed from all sides... Guess we just have to work harder!
PS - Only bonus is that our "new" mortgage is only 25 yr since we have been paying for 5 already.
@Tmoney02: Don't worry! The new housing bill includes a tax credit of up to $7,500 for first time home buyers... that must be repaid over 15 years. D'oh!
My wife and I did a option-ARM loan, because at the time she was in her final year of law school and I was only 2 years in on my career. Our combined gross income has increased almost 3x, so now we can afford larger payments.
That being said, we converted ours to a fixed the second she started working.
D'oh - I meant to include this link, which definitely seems relevant to this discussion, and the entire craphole our economy is sinking into.
/partial sarcasm
I have been wondering how I can default on my loan and get it paid off by the government, considering I am one of those who bought during that time and actually paid my mortgage.
as far as I know, they did. That's the issue in terms of the fallout spreading through other industries ala Bear Stearns. The Sub-Primes were just the first to sink.
Correct me if i'm wrong, but the whole packaging into securities thing is common, but with a traditional 30 year fixed loan granted on legitimate terms (like credit check income etc) the security is ACTUALLY secure as it's backed by an actual house with people with actual money living inside. I think, but am not sure, that sub-primes were ADDED to these securities and spread around. these portions of the securities failed.
I'm probably not correct, but it's close-ish.
Well I was wondering how people afforded the mortgage on a $750K house, and why it cost so much.
The answer was- they couldn't, they were playing with the bank's money and houses cost so much because people were competing to overpay.
@imdgonz: There are no answers here, ie from me. You may want to duck though, this can be an abusive crowd.
@Murph1908: I know you were (half) kidding, but the way to get a gov't bailout is:
1) Be current on payments until this year
2) Have your house depreciate on you
3) Have a high payment/income ratio
4) Convince your lender to write down the value of your loan to 90% LTV regardless of your current LTV
5) Give any appreciation of your home back to the government for the first few years and share it with the gov't subsequently when you sell or refinance
It's definitely a bailout which is unfair to those who are current, but it's not like you're getting a free house
@imdgonz: As business owners you opt to not pay yourselves a salary like a 'normal' employee? Consult your accountant/financial advisor for specifics, but you may want to seriously consider it.
They were like, but your monthly payment will be $500 less a month for 3 years! And I'd respond but what's to stop you from charging my twice that for the remaining 27?
You could always refinance. I did an ARM, and after 5 years, when it came time to adjust my rate, I refinanced and got a fixed rate for the remaining mortgage. I now think the people who are knee-jerkingly afraid of ARM mortgages are suckers.
That's all irrelevant here though. The people getting the interest-only mortgages did so because they planned on flipping the house as soon as escrow closed. Of course when the market fell out and they were stuck with the house, they got screwed. I don't feel sorry for them.
@imdgonz: True -- a good bit of it is "work harder" but if you are being squeezed and may miss payments (IANAL) definitely contact your lender or local agencies before you miss payments to tell them you're in trouble.
We had a couple lenders try to talk us into an ARM or an interest-only loan last summer when we bought. Thank GOD we didn't bite. Thirty-year fixed, all the way. Even though we didn't have much of a down payment (literally, hardly anything) and therefore are paying more with PMI and a slightly higher interest rate, we still went with the 30-year fixed, and I am SO glad.
@RagingBoehner: Exactly. These people are getting something, but it's not much. The major "loss" is on the banks end in regards to the amount of profit they make on the loan.
@sean77
Um, dude, NOBODY is getting refi help right now. People choose an ARM for different reasons, but if your house depreciated in value during the discount period of your loan, you ain't getting refi buddy.
More importantly, it makes more financial sense to walk away from these loans (in SOME, not all, cases) due to points, closing, etc on the refinanced loan.
Suggesting that people scared of ARMs are fools is incorrect. People that make the same kind of money they made when they were to scared for an ARM and opted for a fixed rate are HOMEOWNERS.
@howie_in_az: The resulting income could still be viewed as stated and not earned (like a W2 or 1099) by some lenders.
It's not that folks who have stated income where the problem: folks have been getting stated income-based mortgages for years. It's that lenders weren't properly verifying said income with bank statements or tax returns. Yeah, as a stated income person I could make up any figure, but the onus is on the bank to check and double-check my application, and accept or reject it accordingly. That's what all those closing costs and and points and fees were for.
@sean77: Yes, but what about the people who got an ARM like you in 2003, planning to refinance now? They're screwed, as lenders are reluctant to loan money and their house is worth a lot less than they were planning on.
I have to wonder... why come when people need to pull money out of their house, they look to a refi first and never consider a HELOC?
Because a HELOC doesn't help them at all (long-term) with the higher interest rates their mortgages just reset to.
@sean77: I'm in a similar position. I got a 5 year ARM 4 years ago because I was just starting my career. I'm set to readjust in May but am now making much more money and just plan to refinance early next year.
@B: If you have a solid record of paying your mortgage anyone will lend you money. You've already shown you're not a liability.
@Ilikenumbers: True, but he's right that ARMs aren't all bad. It's knowing what your getting yourself into that's the trouble. An informed consumer can rationally decide an ARM is the best option (no pun intended) but if you are an ignorant or deceived consumer you may not understand the implications. Part buyer beware, part seller pressure, but either way you need to honestly assess whether a loan that resets is right for you.
And besides, if the reason to not get an ARM is that the market is going to decline, perhaps you shouldn't be investing in real estate in that area. Even with a fixed rate mortgage you're still super-leveraged in an asset that you expect to go down in value -- not too smart.
Subprime = anything other than a conforming loan. Alt-A is subprime too, not just poor credit risks (B&C loans).
It was bound to happen.
@m4ximusprim3: They do bundle the "good" loans but those loans provide a smaller revenue stream for investors because the interest rate is lower. Basically with a ton of people in the market chasing money they all started investing/buying the subprime-backed securities because they offered higher returns.
this is why i paid CASH for my home. i got a great deal from the bum on the corner who financed a refrigerator box with an ARM mortgage. He couldn't afford the increase and i got that box at a steal.
i actually rent.
@Murph1908: You need to be a large Wall Street business and a buddy to Federal Reserve personnel. I hear that works great.
I wonder how many of the people crying "stupid" lived in inflating house markets? Yes, this was eventually inevitable - but the market went up and up for a looong time. Many people were quite understandably afraid that if they didn't get in now, they would never EVER be able to afford a home, particularly since every single "expert" was insisting that any price deflation would be teeny tiny. Nobody wanted to be the idiot who waited out the bubble and still couldn't afford more than a one-bedroom apartment for the rest of their lives.
I was a technical consultant 6 years ago. So, I got a LOT of my money in chunks. I never had one solid stream of cash.
The sub-prime loan was designed for people like me. And it worked GREAT! I could pay next to nothing for 6 months then pay all of the balance at once.
It's a shame it was so horribly misused.
@sean77: I know it not on topic, I said I was ignorant of mortgage types when I bought my first house and my initial reaction was to be afraid of any other type other than "fixed". I was trying to understand how, if one is ignorant in these matters, choose any other type because they sound scary. I have refinanced as well, just this past january. It only dropped .3% but still, a better rate is a better rate.
And things change, refinancing isn't always an option.
Oh boy, more economic punishment from stupid greedy people! I keep hearing from my more housing-privileged friends about how they're lamenting the drop in home values. I keep telling them that the market is just correcting back to where it's supposed to be. 5 years ago I was looking at entry-level ($200k properties which I couldn't afford) places in lieu of renting, now those same spots are inching real close to $500k, definitely past jumbo-loan territory. Is this really a crisis or is it merely a case of "reaping what you sow"? People thought their loans were free, well here comes the interest. I still don't even feel comfortable paying $200k, and people I know and respect with less financial means than me were just shooting by scooping up their $350-450k houses they could only afford on an ARM and then crying because inflation is now killing them and their mega-raises didn't come through, and now they are unwilling to sell without a profit. Unbelievable.
What's really scary is reading up on the New Deal again. The whole situation seems quite similar. How in the world are we going to put sweet frosting on the turd this time again so it doesn't stink for another 50 years? The only thing that stopped it was WW2... I mean, there's nobody trying to stir up global conflict again right... oh no.
I still can't afford a house (at current bubble prices), but at least I can afford gas. So hah! Of course by the time I responsibly build up the income and credit to buy, I'll have been shut out by now-fearful banks. And the cycle of recession continues.
Worst part, all these loan packages drove the prices up, causing even more people to use them. Rinse, lather, repeat!
This has only served to hurt those of us that couldn't buy do to layoffs and/or medical expenses.
Any bailout will only serve to prop the inflated prices.
Let the real estate market correct, lick our wounds, and move on.
Yup, tip of the iceberg, were all on the freaking Titanic...
What a mess. Well, good to know our whole economy is about to do a massive faceplant.
You know, I have to admit that the evil Social Darwinist in me feels as though people who bought into property that they can't afford sort of deserve it. Let these people pay for their mistakes with the appropriate consequences, and we'll all be better off in the long run as a result.
Or maybe not so much. :-(
Adjustable rates have their place. I live under my means and got a sweet 7/1 APR, I have been saving like mad and already saved enough to pay off 1/3 of the principal today and I still have 4 years before it adjusts. This is with a wife and family to support. It's just another tool that has been abused by buyers and sellers because of greed and gluttony.
For years I have wondered who the heck was buying all these McMansions that have sprung up around Philadelphia. These places are hellish from which to commute (to Philly or NYC) but they're MASSIVE and in some towns I never saw anything go up that was less than half a mil. Affordable housing near Philly means your house is at least 60 years old (the furnace might actually be older), the schools are mediocre or worse, and the crime rate is not so lovely. So that's where I am, because I got priced out of every decent suburb. And I make decent money!
I just couldn't figure out how all these people were doing it, because, neophyte that I was, I figured they were all doing the 5% down, 30-year fixed rate mortgage that I eventually did. Silly me.
When I was looking to buy my first home my father told me, "The home you live in is not a get rich quick scheme. You can make money in real estate, but don't take chances with the roof keeping my grandkids out of the rain."
So I got a 30 yr fixed, 5.5% interest rate, and a monthly payment that is about 15% of my take home pay.
I'm fortunate because my wife and I do quite well, but so do a lot of people who are losing their homes.
Thanks dad!
I still can't afford a house (at current bubble prices), but at least I can afford gas. So hah! Of course by the time I responsibly build up the income and credit to buy, I'll have been shut out by now-fearful banks. And the cycle of recession continues.
Ditto... here in the DC area. Thankfully, we have low rent and nice digs. But still... we'd like a house. Too bad people hare crazy on pricing (and that's demonstrated by the 10-14 month sales time in our neighborhood).
I know that even the analysts in the story refer to Alt-A's and exotic loans as "prime", just because the borrower has good credit.
BUT...
IIRC from my days looking for a house & loan, "Prime" loans refer to loans written at the prevailing "A Loan" rate, i.e. top-credit fixed rate full doc loans. Alt-A's and exotics pay a premium over prime, which means by definition they are not prime loans.
@howie_in_az: Just an FYI a business owner not paying him or herself a fair salary is considered tax fraud.
@Tmoney02: @Murph1908: @Carso: You all complain about people who couldn't afford payments and stamp your feet and say "no bailouts." But wallstreet already got a bailout in the form of low interest rate loans, government backed loans, etc. (sound familiar to what they're offering consumers?). So if you're going to whine, you should include those banks and wall street firms that got bailed out as well. It's BS that the public pays for the losses but the wealthy get the profits of these companies.
@B: Interest only loans aren't always bad. We have two loans (larger at a lower rate and smaller at a higher rate), so the larger loan is interest only and we take what we would have been paying in principal and apply it to the higher rate loan. That way the higher rate loan is paid off quicker and we add anything to our payment it's even better.
It's ignoring the interest only payment that will bite you in the @## later on.
I was ignorant about mortgages when I bought my home in 2004. But any other option other than "fixed" scared the hell out of me more than the monthly payment savings seemed intriguing. That is all I have to say about that.
What television show had the "CBP" mortgage, the Crippling Balloon Payment"