More Mortgages in Trouble: Neg-Am and Option-Am

The housing crisis is not over if we address subprime or even alt-A mortgages. While the subprime crisis may be peaking, there's another tsunami of defaults coming, this time from "prime" borrowers. Option Arms, Neg-Am's, and Alt-A mortgages, totaling in size of 2-3 times larger than the subprime market, are expected to default in percentages reaching 85% default rate. There are $500B of option arms alone. These products are exotic variations of "interest only" mortgages, but allow the borrower opportunities to pay only part of the interest, while having the rest of the interest charge added to the outstanding principal. Thus, the principal loan on these mortgages actually grows over time. These products usually reset (full interest and principal payments due) 5 years out. There will be a wave of resets beginning in late 2009, peaking in 2010, and ending in 2012. Thus far, only a few have reset, but almost 40% of them are already 2 months delinquent. Against their original plan, borrowers cannot refinance these mortgages because they are upside down on their loans (owe more than their house is worth) due to home price declines. This will be a wave of defaults that will further cripple the financial sector, as holders of these mortgages are the same holders of the toxic subprime debts. Most of these negative amortization mortgages were given to folks with good credit, "prime" borrowers, not the subprime market. Often, they also allowed borrowers to "state" their income rather than "verify" it, and the loans were traditionally "jumbo" in size (but with serious and unique problems that traditional jumbo's did not encompass). Obviously the reason you'd take a negative amortization loan is because you can't afford the purchase price now (or are flipping), but are betting prices will increase so you can refinance later. But that didn't happen, and as principal increased and home value decreased, any equity in the home was/is devastated.

These products were not disbursed across the country evenly like subprime loans, and are located almost entirely in a few states such as California and Florida. The current Senate's plan to stimulate housing with 4% interest rates and a $15,000 credit for homes bought in 2009 will not help this looming wave of defaults.