The Adjustable Rate Mortgage Supply Overhang

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IrvineRenter_IHB

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Adjustable rate mortgages (ARM) became popular early in the price rally because payments were lower, so one could take out a larger mortgage and keep the same payment. After a time, conventional 30-year mortgage payments were too high for most buyers, and ARMs became the norm. Most of these ARMs have either a 3 year or a 5 years fixed rate followed by a ?reset? where the rate adjusts to current market conditions. Most of these loans were originated during a period of historic low interest rates, meaning most mortgage holders will see an increase in payments at the time of reset. Convention wisdom at the time was that these borrowers would simply refinance into another low fixed rate at the time of reset and avoid any real payment shock. However, reality is that refinancing may not be an option in the future as credit standards will tighten, and/or the property may be worth less than the loan. Once a borrower is unable to refinance, it is only a matter of time before implosion. In these circumstances (which will be common over the next several years) at the time of reset borrowers will face a choice: sell and take a loss, or make a much larger payment. Borrowers may not be able to do either one. This will usually result in bankruptcy for the borrower after a foreclosure and another house added to the ?for sale? inventory. The bank will sell at the market: there is no ?holding out for a wishing price? in bank repossessions.



I have been considering the impact adjustable rate mortgages will have on the coming market slide. The above ?reset implosion? scenario will occur over and over again forcing product on to the market until the last of the 5 year ARMs issued in 2006 has imploded. This will create an overhanging supply in the market for the next 5 years. Once this process gains some momentum, it will continue unabated until the supply of ARMs is exhausted. No dead-cat bounce will gain enough traction to make a dent in this overhanging supply. That puts the market bottom in 2012. With 60% of those resets occurring in the next 2 years, you will likely see two years of steep drops followed by 3 years of small drops with some leveling off. By then, nobody will want to own real estate: then, and only then, will it truly be a good time to buy.
 
[quote author="IrvineRenter" date=1168040319]....



I have been considering the impact adjustable rate mortgages will have on the coming market slide. The above ?reset implosion? scenario will occur over and over again forcing product on to the market until the last of the 5 year ARMs issued in 2006 has imploded. This will create an overhanging supply in the market for the next 5 years. <strong>Once this process gains some momentum, it will continue unabated until the supply of ARMs is exhausted. No dead-cat bounce will gain enough traction to make a dent in this overhanging supply. That puts the market bottom in 2012. With 60% of those resets occurring in the next 2 years, you will likely see two years of steep drops followed by 3 years of small drops with some leveling off.</strong> By then, nobody will want to own real estate: then, and only then, will it truly be a good time to buy.</blockquote>


Thanks for putting it so eloquently IR. The bold part is the reason why I will not even bother to start looking for a place until late 2009 to early 2010.



I don't expect to buy at the bottom but I would like to buy within 5-10% of the bottom and of course I would like to buy a home that is 3x the combined gross income of my gf and myself.
 
Thanks for the kind words. It is interesting that even with all the developments over the last 16 months, the basic reasons for the decline are still unchanged. The scenario is moving forward just as it should, although I must admit, the steepness of the declines have surprised me. Anyone who had predicted a 20% decline in 8 months (August 2007-April 2008) would have been labeled a lunatic, but then again, bubbles often crash harder and drop deeper than most imagine...
 
Let me put it this way. Lenders would NOT offer ARMS (specifically 7 years or less) and borrowers would NOT accept ARMS if they new that the home would be worth LESS when the rates adjusted. Considering the previous rapid appreciation and the now sudden descent in prices, you can see the size of the problem.



It's bad.



Let's just pretend that there would be no more foreclosures and every could qualify for a new loan. The vast majority of these people would be looking a significantly higher rates, specifically payments.
 
IR & LM:



As we sit here and contemplate when the bottom would be and how dangerous ARM loans are, home builders are still sending out emails to attract potential buyers to come in and spend very little money on their home purchases.



This came in this morning from John Laing:



You may have heard the good news that changes have been made to the Federal Housing Administration's (FHA) lending policies. Under the new rules, you may now qualify for an FHA-insured loan on a home loan amount as high as $729,750 in Orange County for as little as 3% down payment*.



To help you easily understand how these changes could benefit you, we've put together some simple answers to frequently asked questions about FHA loans. You can read them here.



John Laing Homes currently has several Orange County neighborhoods that are covered under the new FHA program:



Avenue E in Santa Ana

? Priced as low as $320,880

? 3% down payment as low as $9,627



Sendero at Portola Springs in Irvine

? Priced as low as $538,880

? 5% down payment as low as $26,944



Four Quartets at Woodbury in Irvine

? Priced as low as $510,880

? 5% down payment as low as $25,544



StoneTree Manor at Woodbury in Irvine

? Priced as low as $745,880

? 5% down payment as low as $37,294



Come into one of our neighborhoods, talk to a loan counselor and find out how an FHA loan can help you attain homeownership today.



Best Wishes,

John Laing Homes
 
[quote author="lendingmaestro" date=1208485630]Let me put it this way. Lenders would NOT offer ARMS (specifically 7 years or less) and borrowers would NOT accept ARMS if they new that the home would be worth LESS when the rates adjusted. Considering the previous rapid appreciation and the now sudden descent in prices, you can see the size of the problem.



It's bad.



Let's just pretend that there would be no more foreclosures and every could qualify for a new loan. The vast majority of these people would be looking a significantly higher rates, specifically payments.</blockquote>


You mean the same lenders that said, in 3-5 yrs when your home price is HIGHER you can Refi???



For some reason, no one bothered to ask.. "What if my Home is worth the same or lower?" :snake:
 
[quote author="vicstah" date=1208488505]You may have heard the good news that changes have been made to the Federal Housing Administration's (FHA) lending policies. Under the new rules, you may now qualify for an FHA-insured loan on a home loan amount as high as $729,750 in Orange County for as little as 3% down payment*.</blockquote>


The raise in the conforming limit is supposed to be temporary, although I have my doubts. FHA loans were never intended to help people buy $700K homes, particularly at grossly inflated prices. This is another sign of builder desperation. What happens to sales when the conforming limit goes back down? I think we all know the answer.
 
I think that is a bunch of gobbledie-guk from a desperate builder. You can't get a FHA loan for that amount. The CONFORMING loan is temporarily increasing, but there are MAX income limits AND MAX DTI limits to qualify for an FHA loan. There is no way you are qualifying FHA for a home valued over 500k w/o a massive down payment.
 
Hi,



I just started reading this blog about a month ago and am learning a lot! Especially with this thread about ARMs. And pardon my naivete - I hear a lot of people can't handle the ARM resets and it's a big mess right now. I was wondering if there exists:



1. People who knew exactly what ARM loans entail and knew exactly what they were getting into.

2. People who currently have ARM loans and are doing well.



For Question #2, I don't know if there are any good situations with having an ARM loan now and would like to know (as I'm still trying to wrap my head around what's going on)
 
[quote author="small" date=1208497952]Hi,



I just started reading this blog about a month ago and am learning a lot! Especially with this thread about ARMs. And pardon my naivete - I hear a lot of people can't handle the ARM resets and it's a big mess right now. I was wondering if there exists:



1. People who knew exactly what ARM loans entail and knew exactly what they were getting into.

2. People who currently have ARM loans and are doing well.



For Question #2, I don't know if there are any good situations with having an ARM loan now and would like to know (as I'm still trying to wrap my head around what's going on)</blockquote>


[IPO raises his hand] Me me me... I got an ARM in 2001 when I bought, refied into an ARM in 2003 when 5/1's hit 3.875% and will be signing refi docs on Saturday for yet another ARM, this one a 3-year interest-only @ 5%. My reset would have been to around 5% or a bit higher but with inflation on the horizon, I wanted at least one more year at 5% to wait out the market decline further if necessary.



If I hang out for two more years, the average mortgage rate I will have paid will be 4.5% over nine years of ownership. Assuming I did a 30-year fixed back in 2001 and then refied into another 30-year in 2003 when rates his 5.5%, I will have saved 1.25% per year on average over the nine-year period, or around $22K.



ARMs can be great if you use them wisely and on a timely basis. I wouldn't dream of buying now with a short duration ARM. If you only plan on being in a property for a limited amount of time, ARMs can save you big bucks. There is additional risk, and you need to be able to handle the payment shock if plans change though... If interest rates really shoot up over the next year or two, I might consider a longer duration ARM when I buy the next house as I'd expect to be able to refi it down later.
 
[quote author="small" date=1208497952]Hi,



I just started reading this blog about a month ago and am learning a lot! Especially with this thread about ARMs. And pardon my naivete - I hear a lot of people can't handle the ARM resets and it's a big mess right now. I was wondering if there exists:



1. People who knew exactly what ARM loans entail and knew exactly what they were getting into.

2. People who currently have ARM loans and are doing well.



For Question #2, I don't know if there are any good situations with having an ARM loan now and would like to know (as I'm still trying to wrap my head around what's going on)</blockquote>


There are always some who can handle the responsibility, and many people with ARMS are doing well -- until interest rates rise. The final nail in the coffin of the housing market is going to be rising interest rates.



There is a chart on the main blog (and all over the blogosphere) showing the adjustable rate mortgage reset schedule. It shows the enormity of the problem and the timing of the storm will hit. Remember, market prices are set at the fringes. It does not take many transactions to raise or lower prices. Even if a small percentage of the ARM holders go into foreclosure, it is going to have a devastating impact on pricing.
 
ipop is 1 in a million...



He is a trained in finance, was a former day trader and manages the retirement fund for his company.



Very few people are this suave.



I wouldn't use ipop as a typical case.
 
[quote author="alan" date=1208501671]ipop is 1 in a million...



He is a trained in finance, was a former day trader and manages the retirement fund for his company.



Very few people are this suave.



I wouldn't use ipop as a typical case.</blockquote>


Don't forget ex mini-trucker, former Dungeon Master, 3rd string boy's high school tennis singles player, and 5th grade bowling champion (averaged 175 for the league that year)! Aw shucks, those probably don't count for much huh :)
 
Ah, very nice Ipop! Thanks for the reply guys.



Naw, I'm definitely not interested in an ARM. My question was more about, I hear how so many people are getting screwed with the ARM resets, I'm wondering what type/how many people are on top of their game and doing well with the resets...



Just curious. Just want a bigger picture.



If I buy a place right now, it'd definitely be a fixed rate loan.



But then I'm watching my friend telling me an ARM is the way to go, and I don't know how to tell him it's a bad idea.

But then again, I don't know if he's a savvy business guy and knows what he's doing either, so maybe it's good for him.



Do I have this right? If housing prices keep dropping, loan rates will keep increasing?



And now I'm gonna research what has to happen in order for people not to be able to refinance. ;O



Thanks again =)
 
[quote author="ipoplaya" date=1208503984][quote author="alan" date=1208501671]ipop is 1 in a million...



Very few people are this suave.

</blockquote>


former Dungeon Master </blockquote>


"Suave" and "Dungeon Master" are two words that really don't mix well together.
 
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