“The big wave of foreclosures is still coming”

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Blogger’s note: We got an interesting email from a mortgage banker today who raises a point we agree with: the housing mess is far broader than a ‘sub-prime meltdown,’ as it is often called in shorthand. Yes, sub-prime is the first part of the market to collapse, and is driving current foreclosure numbers; but a bigger problem lies ahead:

‘Remember that the current spate of foreclosures relates mostly to: overbuilding in hot spots, fraudulent loans (mostly people falsely claiming they’ll occupy a property) and a relatively small number of borrowers whose subprime rates got jacked way up.

‘The big wave of foreclosures is still coming: people who DO occupy their house and who did not necessarily commit fraud to get the loan, but simply took out an Option ARM and have watched their loan balance grow as their house value has dropped. Those loans allow a low payment for 4-5 years (while the loan balance may be climbing), and since they only jumped in popularity after fixed rates spiked in mid 2003, most of those Option ARMs have not yet even seen the big payment adjustment that’s coming. When their payments double (as they will), many of those borrowers will find themselves with too little equity to either sell or refinance (especially if they had 2nd mortgages on TOP of their Option ARMs). Throw in the tighter underwriting standards that have been imposed recently (making refinancing that much tougher) and you have a still-coming perfect storm. The coming crisis is the ‘Option ARM crisis’, which will make the ‘subprime crisis’ look minor in comparison (at least as far as how real estate values are impacted).

‘The Option ARM foreclosures will only start in mid 2008 and will climax in 2009-2010. The biggest purveyors of Option ARMs have been Countrywide and Washington Mutual. The percentage of homeowners with Options ARMs is highest in California. Think of an Option ARM as a bomb with a five year fuse. Millions of fuses are still burning.’

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Photo Credit: LATimes