March 3rd, 2010 9:32 AM by Lehel S.
More Really Bad News on the Housing Front
Let me begin with the only bit of positive news. In January, housing starts rose 2.8%, the best pace in six months. But that is where the good news ends and the really bad news begins. New home sales in January plunged by 11.2% from December levels to a seasonally adjusted annual rate of 309,000 units, the Commerce Department said last Wednesday. The decline brought sales to their lowest level since the government began tracking the numbers in 1963. Sales were 6.1% lower than in January 2009.
The drop in sales in January triggered an increase in the backlog of unsold new homes on the market, pushing it up to the equivalent of what would normally be sold in 9.1 months versus eight months in December. And the abundance of homes on the market continued to bring prices down. The median sales price for new homes fell 2.4% to $203,500 in January, compared with a year ago.
Faltering demand in the housing market also led to a drop in mortgage applications for both new and existing homes. The Mortgage Bankers Association’s seasonally adjusted purchase index fell 7.3% for the week ended Feb. 19 from the prior week. It is the index’s lowest level since 1997.
Existing home sales last month were also sharply lower, down 7.2%, well below expectations, to a seven-month low. This was the second consecutive monthly decline in existing home sales. And remember that this is happening at a time when there are tax rebates of $6,500-$8,000 for home purchasers. What do you think will happen to home purchases when these tax breaks go away?
Much of this bad news is no doubt related to the plunge in consumer confidence last month and the continued tightness in the credit markets, as discussed above. Unfortunately, weak home sales in January are not the industry’s only problem.
Are “Option-ARMs” the Next Subprime Crisis?
Some housing analysts believe that the option adjustable-rate mortgage market may be the next subprime disaster. Recent analysis from Standard & Poor’s (S&P) anticipates that a full 37.5% of such loans, referred to as “option-ARMs,” that were written in 2007, at the height of lax lending, will eventually go bad.
The problem with option-ARMs begins with the fact that people who took out these loans were given the option to make ultra-low payments for the first few years, and many of them did exactly that. Borrowers who took advantage of these ultra-low payments, mostly middle- and upper-class with good credit scores, were allowed to make payments that didn’t even cover the interest owed (let alone the principal), with the understanding that payments would go up later on to make up for the shortfall.
That allowed people to buy bigger, more expensive houses than they would have been able to qualify for otherwise. Most of these families banked on a good economy and rising incomes by the time the resets took place five years later. Likewise, many assumed they could just sell the house in five years in the unlikely event they couldn’t make the higher payments. Thanks to the recession, the credit crisis and the housing crash, these people are now stuck in their ARMs.
Some option-ARMs have already reset (more on this below), but the bulk of these loans don’t reset until the last half of 2010 and the first half of 2011. By the middle of next year, more than $10 billion worth of option-ARMs will reset higher each month, according to data from mortgage tracker Loan Performance. That comes close to the figures we saw during the subprime crisis.
As noted above, some people with option-ARMs have already seen their payments spike, thanks to caps on “negative amortization” - that is, a loan balance that grows, instead of shrinks, over time. Austin-based Amherst Securities, a big player in mortgage-backed securities, dissected one such loan, which was written in 2007 for $465,000 over 40 years. A minimum monthly payment that started at $1,260 soon rose to $1,354 and then to $2,806, more than twice the original amount. The borrower quickly defaulted.
Even without negative amortization, many borrowers will see their monthly payments jump by 50% or more. According to an S&P study of loans originated in 2005, borrowers who have undergone a higher reset are nearly three times as likely to default as those who haven’t. S&P managing director Diane Westerback warns, “Some of the damage has already been done but the loss projections are increasing.”
With the housing market as it is, borrowers will find few good alternatives for rescue should they run into trouble. The traditional response of refinancing into a more affordable loan is off the table for many homeowners, considering that property prices have plummeted. More than 85% of option-ARM holders owe more on their loan than their house is worth, a situation known as negative equity or being “underwater.” Typically, a refinance is impossible without the borrower having at least 20% equity in a house.
The Obama administration’s big loan-modification effort, the Housing Affordability Modification Program (HAMP), does little to help such borrowers since in many cases lenders will recoup more by foreclosing (the test any loan modification must pass) than refinancing. A recent Bank of America / Merrill Lynch study of loan modifications at IndyMac, which provided the template for broader modification efforts, found that only about 20% of subprime loans had been rewritten, while fewer than 8% of option ARMs were refinanced.
The good news, if you can call it that, is that these loans are very concentrated geographically. About 75% of all option-ARMs were written in California, Florida, Arizona and Nevada, with the vast majority of those in California. People living in Phoenix, Las Vegas and California’s Inland Empire, which have high concentrations of option ARMs, can expect to see renewed downward pressure on home prices. Home prices in some of these areas are already down 30-40%.
Clearly, foreclosures are going to skyrocket again as the bulk of the option-ARM resets kick in later this year and next year. The question is whether or not these will negatively affect home prices around the country, since most option-ARMs are concentrated in only four states. Time will tell but this is not good news for the housing market or the credit markets.