Servicers Facing Boom in ARM Rate Adjustments
The refinancing boom may be slowing down, but servicers have another portfolio churning challenge looming ahead of them.
One expert says that rising rates pose a potentially big threat to housing markets and companies with exposure to real estate values, especially as adjustable-rate mortgages originated in recent years begin to reset at higher interest rates.
Dirk Van Dijk, director of equity research at Zacks, estimates that $1.5 trillion of adjustable mortgage debt will reset at higher rates between now and the end of next year. Moreover, the interest rate on one-year ARMs has increased by about 75% over the last two years, and rates show no sign of dropping anytime soon.
He told Mortgage Servicing News that the $1.5 trillion figure comes from a website that tracks risk issues (calculatedrisk.blogspot.com).
Mr. Van Dijk notes that housing is "far more leveraged" than the stock market as an asset class. Most recent home purchases have been made with less than a 10% downpayment and the balance financed, he said, often with variable-rate loans. While foreclosure rates remain low, he says it is likely they will increase in light of the rate increases.
"Lenders were aggressively pushing ARMs with low introductory rates a few years ago, and it was generally easier to qualify for an ARM than a fixed-rate mortgage. Thus the people who have the fewest financial resources to fall back on are the ones who are most likely to face large increases in their mortgage bills. As transaction volumes fall, it will become more difficult for people who can no longer afford their homes to simply sell the house," he predicted in a recent article for Zacks.
Historically, Mr. Van Dijk said banks have been quick to sell foreclosed real estate without a lot of price sensitivity. If a big increase in bank-owned real estate has lenders dumping properties, that in itself could put additional downward pressure on prices, he said.
In addition, as ARMs reset at higher rates that could create other problems for the economy, Mr. Van Dijk explained. Many consumers chose ARMs to increase their buying power, but they did so at a low point in the interest rate cycle. "There has been an awful lot of these adjustable rates taken out and a lot of people were taking them out at exactly the wrong time," he said.
Moreover, banks eased underwriting on ARMs, making it easier for some consumers to qualify for an ARM than for a fixed-rate loan, a development Mr. Van Dijk says was "incredibly short-sighted for the banks" to do. He now believes that the "bubble" in home prices has come to an end.
"I'm nervous about the possibility of a lot of foreclosures because it could start a nasty snowball effect."
A wave of foreclosures could lead to heavy selling of bank-owned real estate, depressing nearby property values. That in turn could leave more borrowers "under water," owing more than the house is worth.
But even if property markets don't take a dramatic hit, the ramifications of a longer-term stagnation in home prices are interesting to contemplate. If, instead of collapsing, real estate prices stay where they are for a decade, that would affect consumer spending, inflation and employment.
Stagnating home prices might encourage some people who would otherwise purchase a home to rent, but with the rental housing stock growing at only a slow pace, that trend could push up rental prices. In recent years, landlords have lost many tenants as people rushed to take advantage of low rates and purchase homes, putting downward pressure on rents.
In turn, weak apartment rental prices have helped keep a lid on the Consumer Price Index, Mr. Van Dijk noted. As rental prices rise, that in turn would put upward pressure on the CPI, just at a time when the Federal Reserve Board is focused on containing inflationary pressure.
"The fed's medicine could make the patient sicker," Mr. Van Dijk said. "The unwinding of bubbles is not pretty."
David Berson, chief economist at Fannie Mae, said the huge volume of ARMs that will reset over the next year-and-a-half could help keep the refinancing market alive, as some borrowers refinance into fixed-rate loans or new ARMs. In addition, some subprime borrowers with good payment histories may actually be able to lower their interest rate even if overall rates rise. (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com