scariest data ever: 33% of Seattle mortgages are IO/neg-am
I find the data showing that interest only and negative amortization loans were 33% of ALL mortgages in the Seattle area for 2006 the scariest piece of real-estate data out there.
Sure, afordability, sub-prime, inventory, and appreciation data are interesting, but the over-all prevalence of dodgy financing is the biggest indicator of market health, in my view.
http://www.recharts.com/reports/CSHB031207/e31.gif
Nationally, we can see that IO and neg-am loans are prevalent even in prime mortgages.
http://www.recharts.com/reports/CSHB031207/e30.gif
It is MOST interesting to see that the deterioration of mortgage quality goes far beyond sub-prime. 36% of 2006 US prime mortgages were with no documentation. With so little scrutiny of borrowers how do we know these are truly "prime"?
http://www.recharts.com/reports/CSHB031207/e32.gif
Sure, afordability, sub-prime, inventory, and appreciation data are interesting, but the over-all prevalence of dodgy financing is the biggest indicator of market health, in my view.
http://www.recharts.com/reports/CSHB031207/e31.gif
Nationally, we can see that IO and neg-am loans are prevalent even in prime mortgages.
http://www.recharts.com/reports/CSHB031207/e30.gif
It is MOST interesting to see that the deterioration of mortgage quality goes far beyond sub-prime. 36% of 2006 US prime mortgages were with no documentation. With so little scrutiny of borrowers how do we know these are truly "prime"?
http://www.recharts.com/reports/CSHB031207/e32.gif
Comments
Check me on this, but I don't believe this chart
It shows Sub-Prime, Alt-A, and Jumbo. Prime mortgages are not on the chart.
am I missing something?
Funny. I just clicked on the links in the thread and they worked fine for me.
Nice work Snig....
The way I see it, the primary reason anyone gets an IO or neg-am loan is because they can't really afford the home they are buying. With such large percentages of prime borrowers stretching themselves beyond any rational limit it would seem there is virtually no cushion in the system to weather a market downturn. This is yet another reason I stand with Eleua in believing there is going to be a DEEP retrenchment before all is said and done.
http://www.recharts.com/reports/CSHB031207/e30.GIF
He said he is just paying off the interest, nothing more. I know that he put at least 20 percent down on his house, his reasoning for going IO was that he didn't expect to be in the house long. Well it's been about 4-5 years now and they are going to be in the house for a while longer....
I know several people with IO loans that didn't really need them. Depending on the spread between IO and 30 year fixed, it can actually be a very flexible loan to get if you're the kind of person with financial discipline.
Assuming that the spread is small (I *think* it's just a couple of tenths right now), I can get the 10/20 IO (30 year term) and make extra payments as if I wanted to amortize the loan over 30 years. All you have here is a slightly more expensive 30 year fixed.
Now, if I lose my job, get sick, etc, then I can revert back to the IO amount. Sure the majority of people don't have this discipline, but I don't think it's entirely fair to formulate an opinion that anyone with an IO loan couldn't afford their house.
It turns out that we are experiencing a spike in Californians and are taking out a bunch of kinky loans.
My entire world-view has been turned over.
Don't forget the specuvestors! A zero down, IO or neg-am loan is an excellent way to leverage yourself into that guaranteed annual appreciation of 10 to 20 percent of purchase price.
..
sniglet -
Jumbo loans are not "prime loans". they are by definition "non-conforming". So the second chart shows everything BUT prime - which I think is 50% of the market, if I recall. Your chart reflects the other 50% of the market
Perhaps I mis-interpreted the graph. I thought the "Jumbo" loans must be prime. I know many people with very traditional "jumbo" loans, that are such merely because the dollar value of the loan is greater than what is covered by Fannie Mae.
A year ago I chose to get an IO Mortgage because it carried a lower interest rate and had a cheaper payment...it was a no-brainer. I also just plugged the extra money and more into my HELOC (an account I can write checks against). Currently I have over $11,000 in extra money I have been throwing in there whenever I have spare cash from my paycheck in only the last year.
carlislematthew & Matthew - You are correct that the spreads between the IO and 30-yr fixed are marginal. At this time Im refinancing (not pulling money out with the REFI, gasp!) to get rid of my 2nd mortgage (thus have 20% equity and getting rid of the high rate loan). When comparing the rates, the IO was only 25bps lower...hardly worth pursuing. However the after tax benefit of my 6.54% APY mortgage is ~5% rate of return. Over the past 8 years (since I started investing) I have never had a negative YOY stock market return and 2006 was 24%. So far this year Im up 14% (one really good stock and one really bad to balance out my portfolio). Still have a lot of Boeing stock from when I worked there 8) .
Overall it would be interesting to see a study of people that "had to" get an IO or "chose" an IO...there was a time that it was financially smarter to do so a few years ago.
re: I/O study.
The leverage a large number of people are utilizing their homes for really does concern me. It's remarkable. The use of I/O loans where people have to use this financing or choose to is rampant. Reminds me of the auto business. No longer is it on the minds of people what the the total cost of a vehicle is, but just the monthly "rental" fee. It is more often than not that people only allocate a certain amount of the budget to the monthly payment ($500-600-700 not including operating, insurance and maintenance costs). They don't pay for the $40,000 F-250 truck outright. Can't.
Being in the escrow business is like always getting backstage passes to see every major concert coming to town. In other words, you can't get any closer to the action of the market and what people are doing. It is an amazing position to be in during these times in the market.
Numerous refinance and purchase borrowers cannot afford a 30 yr fixed rate with PITI. In 2006 it was a stunningly profitable endeavor for those in the loan business placing people into 80/20 I/O deals. If you could earn the rebates on upselling pre-payment penalties, the money flowed like water over Niagara Falls. Utterly amazing checks we were cutting out of escrow.
Sample: an acquaintance of my wife purchased in late 2005. Around $550K with 1st/2nd ARM financing. Refinanced since ownership. Outstanding loans are $750K. Is the house worth that? The latest financing is a 1 yr ARM on the 1st; the 2nd mtg. is probably around 9-10% and there is a 2 yr prepayment penalty that we calculated at $18,000. Where has the money gone? You name it. Their lender is heavy sub-prime.
Granted I'm cheap, but I don't know how in the heck people think it is normal to spend darn near $70000 to live in a place that would rent for probably under $2000/mo. These folks are a classic example of "have to" obtain I/O financing. Unfortunately, they may be in a situation where they cannot refi again and turn into a "have to sell" seller. But, what can you do?
The sad thing is we are watching a few existing clients dip into the housing ATM and leverage the living hell out of their home to buy another "investment" to flip. Came way too late to the party.
True "prime" loans are 45% of the money - and by definition, since they are "conforming" can't have IO/neg-am features.
so what's at risk is the other 55%, and only 12% of the money is in Jumbos.
Neg-Am and IO as % of total $ = 21.6%
Subprime - 4.6%
Alt-A - 12.4%
Jumbo - 4.6%
Prime - 0%
Personally, I would argue that Option-ARM and IO loans are less susceptible to payment default than straight ARMs. A 10 year IO loan locks in a pretty low payment for a long time. The owner may end up under water on the property, but are they are less likely to walk away because they cannot make the payment. I think the riskiest loans are the 2/28 sub prime ARMs, which we are seeing reset right now. I doubt you will see default rates as high as we are seeing on these loans for any other class of lending.
Interesting... I would have thought it was the reverse. I had been working under the assumption that most people getting neg-am and IO loans were doing so precisely because they were stretching themselves to the max and couldn't really afford the home. If this was the case (i.e. that the mortgage holder had leveraged themselves to the eyeballs) then they would be be at high risk for default.
What can certainly be said is that there could be much more of a hit in the monthly payment if a holder of such a loan wanted to refinance into a more traditional vehicle. By contrast, someone with a traditional ARM might not see the same degree of payment shock when refinancing into something like a 30-year fixed.
I will admit that my assumption may be incorrect (i.e. that most people with net-am and IO loans are doing so because they can't afford a normal payment.
Those with I/O Neg. Am. ARM's and Shorter Terms are generally forced to play their hand when the adjustment period begins. Much more often than not, they are tied to pre-payment penalties which theoretically discourages refinances, but by my experience has done nothing of the sort.
Goes without saying that the Neg. Am. loans are also reducing equity position by the nature of the loan increasing principle to 110% cap of original note.
Are you suggesting that people with long-term IO ARMs are going to default at a lower rate than people with traditional long-term positive amortization ARMs? My supposition was that there would be a higher number of defaults amongst any IO ARM and an equally dated traditional ARM. This is based on the theory that IO loans are particularly attractive to people who can't really afford the home they are buying (i.e. they are attracted to the artificially low payment).
If they owe twice the value and the bank gets stuck with it, even better?
not saying that's still the case - but my theory is that increasing payment are the big driver of default. sub-prime generally reset in 2-3 years. Alt-A usually goes to 5/7/10. So an IO sub-prime is a nasty loan, but I think Alt-A w/longer reset - people will try to ride it out.
If I could just find that reset chart in the blog, you can when they reset pretty clearly
Of course, if this thing goes down 5+ years... look out.
edit: here is a link with pointers and everything!
Adjustable Rate Mortgage Reset Schedule
I am sure there are some people getting IO loans for sound financial reasons. But I really wonder if this is the majority. I personally know a few people with great incomes and credit scores who got IO loans because that was the only way they could afford to buy the $800,000+ homes they wanted, and weren't willing to settle for something smaller.
These people are gambling on the housing market continuing to appreciate so that they can refinance into a different loan. I wonder how many other people are using IO loans like that? In any event, I suspect these loans lend themselves to abuse.
40 years ago, such talk of using neg-am loans to allow someone to speculate elsewhere would be viewed as lunacy. What strange times we live in...
Tanta explains it well, but essentially it "catches the borrower up" so that at 5 years, it reamortizes the loan, often increasing payments, and these loans also have rolling recast options that never let the loan get above 110% of the original balance. This can mean large, apparently random increases in mortgage payments.
Would these people be as motivated to try and keep a home in the face of a market downturn as those who have a big chunk of equity tied up?
Let's put it another way. If home prices had fallen 15% which owner would be more likely to hand the keys to the bank when they needed to move because of work:
- owner A who had a traditional 10 year ARM with 20% down
- owner B who had a 10 year IO loan with 10% down
I would bet anything that more people in owner B's situation would decide to just walk away if they were under-water. And clearly it is MUCH more propable that people with IO and neg-am loans would wind up under-water in a declining market than those with positive amortization mortgages. Even if owner A and B had started with the same down-payment, owner B would have far less equity over time, and would end up under-water long before owner A.
Any way I look at this, it would seem that IO and neg-am loans would have a higher risk of default than the traditional mortgages. The fact that the rate spread between these loan types is so low today is just further evidence at how out of wack our financial system is. Just as the industry is now re-evaluating the risk of sub-prime loansm, I think they will wind up having to reprice the entire cornucopia of exotic mortgages that have emerged in recent years.
Well, how many americans pay off their credit cards every month? Do they declare bankruptcy because they are carrying a huge balance, or because they can't afford the payments?
I'd argue it is the latter, not the former.
How about cars? People are under water on them as soon as they drive off the lot. Do they turn the keys in because of that, or because the payments are too much for them?
Apply the same logic to your two scenarios, if they can make the payment - they keep the house. I don't think people are going to default or declare bankruptcy just because they are under water on their loan. It's all about cash flow. Income statement, not balance sheet.
But what in a situation where they HAVE to move (due to job, or whatever) as I posited in my scenario? True, it may well be that the home-owner with the IO loan who is under-water would agree to stump up extra cash at closing, but there is no such fear of the owner who still has equity to close.
I am NOT saying that all people with IO loans will default. I am just saying that there will be a higher rate of foreclosures for IO loans than the traditional varieties because a greater number of them will be under-water. It is well understood that foreclosure rates are MUCH higher for people who are under-water.
sorry, I completely missed that "needed to move because of work" part...
that's probably true. I wonder how many people that will affect. What I have read is that in a downturn, velocity of home sales drops precipitiously, which fits with people sitting on their homes.
the few that have to sell are screwed, and writing a 100k check to the bank sucks. in declining order, options are 1) get your new employer to pay for loss (only for mid/sr execs is this a reality, but it does happen pretty frequently) 2) short sale 3) FC or Bkruptcy
We'll see how it plays out. I think FC rates will rise vs. the historical means, but I believe the worst of it is going to be over the next 12-18 months as the short-term resets hit sub-prime.
So, it sounds like we are all in agreement that it is highly likely that IO and neg-am loans will default at a higher rate than traditional mortgages (when comparing like maturities, etc).
Which brings me back to my earlier point: the huge growth in the use of IO and neg-am loans will result in a deeper real-estate down-turn than would otherwise be the case if only traditional mortgages had been used. And this applies even to prime borrowers.
This state of affairs would never have happened if risks were being properly factored into prices. It's just insane that an IO/neg-am loan can be had for only a slightly higher rate than a traditional mortgage. Sure, this makes sense for the borrower, but the lenders have set themselves up for disaster by making it so easy for home-owners to cut their losses if the real-estate market turns down.
If there is a signifance drop in real-estate prices, why not just turn in the keys if your home is deeply under-water and move into a nicer rental that has a lower monthly fee? If you don't have any equity it's almost a no-brainer. The only thing you will lose is your credit rating, which is a small price to pay for being able to get out from a hundred-thousand dollar (or more) negative equity loan.
Or to put it another way: if the only down-side to giving a home back to the bank was a trashed credit rating (and laws in many states prevent lenders from going after anything more than your primary residence), why would anyone keep making payments on a home that was under-water if they could find a better place to rent for a much lower monthly fee?
and