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Just over a year ago I took a Close Look At The
ARMs Reset Problem.
Inquiring minds may be asking "What's Changed?"
The answer is: there has been much improvement across the board, but
especially for 5-1 ARMs. In addition, those in ARMs tied to the Cost of Funds
Index (COFI), will be pleased to note that on April 30, the COFI sank to an
all time low.
The History of COFI shows the March 2009
index value at 1.627, a record low. A year ago index value was 3.280. Last
month it was 2.003.
COFI is the weighted average of the cost of funds (CDs, savings deposits,
checking deposits, etc) for member banking institutions of the Federal Home
Loan Bank of San Francisco (the 11th District). COFI is a lagging index. The
index value for a given month is typically reported on the last day of the
following month. For Example: At or after 3 p.m. on the last business day in
September, the bank announces the August COFI.
The most common indices used to compute ARMs are COFI, 1-Year Constant
Maturity Treasuries (CMT), 1-Year LIBOR, and 1-Month LIBOR.
Rate Comparisons - COFI, 1-Yr CMT, 1-Yr LIBOR
Those in interest only loans are
frequently tied to 1-Month LIBOR.
1-Month LIBOR
All charts courtesy of Money Cafe.
ARM Index Rates
COFI - 1.627%
1Yr CMT - .64%
1Yr LIBOR - 1.97%
1Mo LIBOR - .41%
ARM rates consist of an index rate (typically one of the above), plus a
margin component (e.g. 1 Month LIBOR + a spread). The amount of the spread is
based on credit risk and other factors at the time the loan. Regardless of
what index rate is, ARMs that are now resetting are likely to be coming in at
lower rates, perhaps even much lower rates.
1 Year CMT Table
One Month LIBOR Table
One Year LIBOR Table
COFI Table
Across the board, those in
3-year ARM rates that have recently reset or are about to reset, will do so
at a much lower rate unless there is a floor. Moreover, with the specific
exception of 1-Year LIBOR based loans, there will also be a reduction in
5-Year ARM rates when those loans reset. Looking ahead just one month, even
5-Year ARMs tied to 1-Year LIBOR are likely to reset lower.
Thus, even homeowners ineligible to refinance now because they are underwater
on their homes, have already (or soon will) see a significant reduction in
mortgage interest rates (assuming there is no floor that prevents rates from
going lower). I do not have stats on the percentage of loans with and without
a floor, but even with a floor, rates should not rise.
Principal Payments Need To Be Factored In
There is still one more issue to address, and that is higher payments when
the interest only period ends. For example, a 5-year ARM loan typically goes
from interest only payments to interest + principal amortized over 25 years
on the first rate reset. Likewise a 3-year ARM loan typically goes from
interest only payments to interest + principal amortized over 27 years on the
first rate reset. Some ARMs have a 10 year interest only period which
postpones this particular problem.
Across the board, those in 3-Year ARMs with principal and interest payments
will likely see their total mortgage payment drop. However, those paying
interest only, especially those in 5-1 ARMs, may see their total payments
rise. Even so, the situation has hugely improved from a year ago.
Pay Option ARMs Still A Problem
The problem with Pay Option Arms
is over 80% of POA mortgagees only make the minimum payment. Given that
minimum payments typically do not cover interest owed, the loan balance
increases every month. This is called negative amortization, and it has been
going on for years.
Negative amortization is compounded by falling home prices. At some point,
typically 110-125% of the mortgage, an enormous gotcha kicks in. That gotcha
requires a fully indexed fully amortized principal and interest payment,
amortized over the remaining years. People who could only afford the minimum
payment will be forced to pay principal, plus interest, on top of a loan
balance that has been growing monthly. Good luck on lenders getting all their
money back on those loans.
The second problem in regards to POAs is that a huge portion of these loans
originated if the least affordable, biggest bubble areas, like Florida, California, Las Vegas, etc. From a lender's perspective that hugely increases the
likelihood of default as well as the size of the problem should default
occur.
Conclusion
Other than the ticking time bomb of Pay Option Arms (which is still a huge
problem, especially for California), the ARM reset problem has vanished for
as long as rates stay low, or permanently if ARM holders roll over into
affordable fixed rate mortgages.
Unfortunately, reset issues are not the only problem. The economy is still
losing 600,000+ jobs a month and for every job lost there is another person
who might be shoved into foreclosure as a result.
Mish
GlobalEconomicAnalysis.blogspot.com
Mish's Global Economic
Trend Analysis
Thoughts on the great
inflation/deflation/stagflation debate as well as discussions on gold,
silver, currencies, interest rates, and policy decisions that affect the
global markets.
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