I’ve hesitated to write this entry because I don’t know how to get across what I’m trying to say.

Basically, it’s this.

Over the past several years, homebuyers have taken out adjustable-rate mortgage loans in order to buy as much home as possible, for as little money as possible. Adjustable-rate loans tend to be at lower interest rates than fixed-rate loans. The kicker, of course, is that after some pre-set time period, usually six-months to seven years, the loan interest resets. There’s usually a limit on how much higher the interest rate can go, within any twelve-month period (sometimes around 2%) and over the life of the loan (sometimes around 6%).

If you took out a fixed-rate loan, say at 6%, your mortgage loan payments will stay the same, every month, for the next thirty years.

If you took out an adjustable-rate loan, however, say at 5%, your mortgage loan payments could potentially go up, every six months or every year, until it hits a really high number, say 11% or so.

Banks sometimes offered even lower, “teaser” rates, to encourage borrowers to use them. You could get a 1% loan, for example, good for a year or two.

Borrowers liked it because they could buy a lot of home for the money. They focused on today, ignoring what was going to happen, down the line, when the loan reset, and the interest rate jumped.

Many assumed they’d be able to refinance into a fixed-rate loan, or into a new, low-rate ARM loan, or that they’d sell before it reset, or that they’d make more money and be able to absorb the higher payment into their budget.

While interest rates stayed low, everyone was happy.

Lately, however, rates have been going up. So lots of borrowers could be facing trouble. And, since the housing market is slow, these homeowners might not be able to sell their homes, even if they wanted to. And, since the housing market is slow and home values are stable or even dropped a bit, borrowers may not be able to refinance into fixed-rate loans, because they owe more on their loans than what their homes are worth.

So, if we look at borrower behavior, we can get an idea if we’re in for a heap of trouble.

David Berson, Fannie Mae’s chief economist, analyzed a bunch of loans that were fixed for the first two years, then adjusted after that, to see how borrowers behaved.

These loans are known as 2/28 loans (logically, right?).

They are good indicators of future problems because these are the first loans to reset after the hey-days of the 2005-2006 housing “bubble”.

So, what happened? (Okay, if you’re still with me, thanks.)

Of 2/28 loans taken out in 2004, which reset in 2006, 76% refinanced. The borrowers could have taken out new ARMs or fixed-rate loans, and they could be prime or subprime loans. Still, it’s probably safe to say that these people were able to find better loans than they had before, and/or they could delay facing loan payment increases for awhile longer.

Twelve percent of borrowers held onto their 2/28 loans, 6 percent are “delinquent” (more than 30 days past due, I think), 4 percent are in default, and 2 percent are in foreclosure.

Okay, here’s the point (if you’re still with me, thanks).

For loans resetting in 2007, results are less reliable, because we only have the first quarter’s data to analyze.

Things aren’t so rosy.

[A]s of March 2007, 37 percent of the 2/28 subprime borrowers with rate resets in 2007 have prepaid, and 45 percent are current.

However, 11% are delinquent, 3% have defaulted, and 4% are in foreclosure.

So, those taking out loans in 2005 are having more trouble making their payments. Delinquent loans are almost double what they were the year before, as are those loans in foreclosure.

There are so many reasons for this, some very logical.

Prices were still rising in 2005, so homebuyers bought at the very height of the market, and have few if any options, if they are looking for a way out of their loans (for reasons I explained, above – less or no home equity, higher interest rates, inability to sell their homes).

We’ll have to keep an eye on this.

More: Stressing Subprime Mortgage Rate Resets – Jonathan J Miller, Matrix

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Updated:  1st Q 2018

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