The number of people falling behind on their mortgages increased over the last quarter for the first time since 2009, according to a new report by the credit bureau TransUnion.
And while the news surprised many people, it came as no surprise at all to some mortgage experts, who have known for years that a wave of wildly risky mortgages written in the waning days of the mortgage boom would come back to haunt the American economy in 2011.
That means the mortgage market meltdown that began in 2007 is headed for a double-dip, and likely won’t get resolved until 2015, says Dr. Joseph R. Mason, a banking professor at Louisiana State University and a senior fellow at The Wharton School.
“These loans are the worst of the worst of the worst,” Mason says of some of the riskiest sub-prime adjustable interest rate loans, many of which are now resetting. “These loans never should have been underwritten in the first place.”
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Mason asserts that these loans are tied to the recent troubling mortgage numbers. The national delinquency rate of borrowers going 60 days or more past due on their mortgage payments increased to 5.88 percent during the third quarter of 2011, the first increase since 2009, TransUnion found. The rise in late payments came after six straight quarters of decline.
“We expected that trend to continue given recent, relatively more conservative lending policies and the apparent stabilization of both home values and unemployment,” Tim Martin, chief of U.S. Housing for TransUnion, said in a press release.
The company blames the increase on a variety of factors.
“In the third quarter, the consumer was hit with several unanticipated shocks, including the U.S. credit rating downgrade, stock price declines, European debt concerns, stubbornly high unemployment, more downward pressure on home values and low consumer confidence,” Martin said.
Sure, none of those things helped. But according to Mason, the real cause is much simpler than all that. Pure and simple: It’s the loans themselves. In 2006 and 2007, lenders had largely run out of qualified borrowers to buy homes. But banks and other lenders were still making lots of money from fees generating by selling mortgages to individual homeowners, and other fees from bundling those loans together and reselling them to investors.
To keep that pipeline of cash flowing, many allege that banks threw lending standards out the window (economist Kathleen Engel covered this trend in her book “The Subprime Virus“). Some of the riskiest loans were called Pay-option ARMs. In this case, “ARMs” stands for “adjustable rate mortgages,” in which the interest rate fluctuates over time. There’s nothing necessarily risky about that.
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The risk comes in the “pay-option” part, Mason says. Typically these loans gave borrowers the option to make minimal payments at the outset of the loan. Not only did they not have to pay toward the principal, they didn’t even have to pay all the interest as it accrued. This “teaser” period usually lasts five years.
The practice helped people get loans they couldn’t actually afford, Mason says, adding that many such borrowers were spending 40 percent of their incomes to pay down credit cards and other forms of debt before they ever bought a house.
“These loans were already defective right from the start,” says Mason.
After the teaser period is over, the loan resets. All the principal and interest payments that were deferred during the first five years get added to the total price of the loan. Only now, instead of 30 years to pay it off, five years have elapsed. That means the borrower has just 25 years to pay the entire balance.
The result, Mason says, is that monthly payments can jump by 300 percent.
In this case, the math is simple. If pay-option ARMS took off in late 2006, then of course those borrowers would begin having trouble making their payments beginning five years later, which means right now. Just under $24 billion worth of pay-option ARMs were expected to exit their teaser periods in October 2011 alone, according to a projection made in 2009 by Credit Suisse.
“You don’t even need to go to the economics,” Mason says. “Because in no state in the world can these borrowers handle that level of payment.”
This increase in late payments is only the beginning of the bad news. Most borrowers with pay-option ARMS have yet to actually default, and the homes will go through foreclosure after that, which will take another two or three years.
All of which means these bad loans will continue hurting the mortgage market, and putting a crimp in home values and sales, through about 2015.
“The good news is we’re getting all this behind us,” Mason says. “But it takes time.”
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Image: sean dreilinger, via Flickr.com