More Foreclosures Ahead for ARM Borrowers

March 19, 2007 — -- A new study released today finds that 1.1 million adjustable-rate mortgages will end in foreclosure over the next six to seven years as millions of homeowners face increases in their monthly mortgages payments, some more than doubling.

These mortgages -- both prime and subprime -- represent 13 percent of the adjustable-rate mortgages, also known as ARMs, issued from 2004 to 2006.

The 1.1 million only include foreclosures due to homeowners being unable to make higher monthly payments after their ARMs reset to higher interest rates. The study does not include foreclosures that could be the result of a homeowner being unable to make monthly payments due to a loss of job or an illness.

The study was conducted by Christopher Cagan, the director of research and analytics at First American CoreLogic.

Subprime Borrowers at Risk

Cagan studied 26 million loans, examining 8.37 million ARMs representing $2.2 trillion. Of those ARMs, he calculated that one in eight, or 1.1 million, will end in foreclosure. These 1.1 million mortgages represent $326 billion, and Cagan estimated that in the end, lenders will lose approximately $112 billion.

But the pain will not be evenly spread out among homeowners. The risk of foreclosure will be highest for those borrowers who obtained mortgage loans with teaser rates (extremely low initial rates, often interest-only, that quickly adjusted upwards) or subprime loans.

Cagan found that of the 1.1 million foreclosures, 32 percent will be teaser loans and 12 percent wille be subprime, while only 7 percent will prime ARM loans.

Despite the figures, however, Cagan was optimistic about the state of the housing industry and the economy overall. From his analysis, he concluded that while individual homeowners will suffer in the years ahead, nationwide the total losses will equal less than 1 percent of the total U.S. mortgages lending during that period. Cagan predicts that the impact to the national economy will be minimal.

"Our nation has a $12 trillion per year economy, with total mortgage lending of about $2 trillion per year," he wrote in the report. "Losses of $112 billion spread over five or six years average out to $19 billion per year over six years and $22 billion per year considered over five years. Such losses constitute about 0.17 percent of the national economy, and about 1 percent of the total amount lent per year.

"Therefore, I conclude that foreclosure losses due to mortgage payment reset will not break the national economy or the mortgage lending industry as a whole. However, this study has shown that the impact of reset will not be spread evenly. The slice of borrowers, lenders and investors who have been exposed to teaser or subprime adjustable loans made with low down payments may suffer financial loss."

Even without losing a home, just making the monthly payments will become extremely challenging for many homeowners with adjustable-rate mortgages in the years ahead.

Cagan's research found that more than 2 million households will see an increase of more than 50 percent or more in their monthly payments. Of that number, 1.2 million will see a 100 percent or greater increase in their monthly payments.

Some Other Stats to Keep Handy

RealtyTrac, a foreclosure tracking firm, found that more than 1.3 million homes entered some stage of foreclosure last year, a 42 percent increase from 2005. It predicts this number will increase 20 to 25 percent this year.

It is worth remembering that not every home that enters into foreclosure eventually is taken over by the bank. Many homeowners are able to negotiate their way out of foreclosure, sometimes even by selling the home.

Mark Zandi, chief economist with Moody's Economy.com, concluded that approximately 400,000 subprime loans went into foreclosure in 2006. He believes that number could double in in 2007.

And finally, according to the Mortgage Bankers Association, the total outstanding mortgage debt is currently estimated at more than $10 trillion. Of that, more than 13 percent are estimated to be subprime loans, or approximately 6 million homeowners.