Concern over the effect adjustable-rate mortgage resets will have in upcoming years are downplayed in a recent study, which also notes equity-shy markets are likely to suffer most from adjustments.
Because mortgage "payment reset is likely to be the most important issue facing mortgage servicers and investors in the nonprime market during the next few years," First American Real Estate Solutions did an analysis on who will be most affected when ARMs convert from low, teaser interest rates to higher prevailing mortgage market rates.
The Mortgage Payment Reset: The Rumor and the Reality study reportedly investigated the impact of mortgage payment reset by utilizing the database and analytical resources of FirstAm RES and its subsidiary LoanPerformance to classify market segments, arranged according to homeowner equity as a percentage of each home's market value, as relatively safe or vulnerable under the pressure of mortgage payment resets.
In analyzing the cumulative equity of borrower groups according to the year their first mortgage was originated, it was found that 8.4 percent of those who purchased or refinanced their first loan in 2003 have zero or negative equity, while 29.0 percent of those who purchased or refinanced in the first three quarters of 2005 were in that situation, according to the study, by FirstAm RES director of research and analytics Christopher Cagan.
Furthermore, as of September 2005, 9.4 percent of homeowners had negative equity, but this does not indicate all these individuals are in trouble.
The mortgage loan database included nearly 20 million first mortgages originated in 2004 and 2005, representing almost $4 trillion in debt. Of the set, 7.7 million were active adjustable-rate first mortgages, representing nearly $2 trillion in debt, and most will not face reset sensitivity over the next few years, according to the study.
"Most households purchase a home to live in for several years or even decades and do not face an imminent sale," Cagan wrote. "Moreover, many homeowners have fixed-rate mortgages; if their employment and income continue and they are not planning to sell their properties or borrow to the last dollar of value, they can easily wait out any dip in prices until their equity builds. Thus, it is only a smaller group of homeowners, 'a slice of a slice,' that may actually find themselves in difficulty."
According to FirstAm RES, "The most vulnerable will be those who do not have substantial equity in their homes, but hold adjustable rate mortgages ... with low initial rates, often with interest-only and negative- amortization features."
The most vulnerable borrowers are those with initial teaser rates under 4 percent, which make up about 18 percent of the ARMs originated in 2004 and last year and have a total loan amount subject to reset sensitivity of about $431 billion, the report said.
The author noted the sensitivity is worse particularly for borrowers in loans with a 2 percent or lower teaser rate. Such loans are about 17 percent of the ARM originations in that time, representing $389 billion of debt, the report said.
"When the loans finally adjust to fully-amortizing market-rate levels, the payments will have increased by more than fifty percent from their initial amounts," the author wrote. "Often the payments will have doubled, or more than doubled."
The states where fewer borrowers have significant equity and face greater likelihood of experiencing reset sensitivity include Tennessee, where almost 48% of borrowers have 15% or less equity and 28% of borrowers have 5% or less equity, Colorado, Michigan, Alabama and Arkansas, the report said.
On a national level, however, the impact of mortgage payment reset and subsequent default will not significantly impact the economy. The adjustments will result in approximately $110 billion in losses, or less than 1 percent of total U.S. mortgage lending annually, and well below 0.5 percent of total mortgage debt outstanding, according to the study.
The states with the lowest percentage of high-risk properties include New York, Hawaii, Massachusetts, Connecticut and New Jersey, as well as Florida and California, because prices tend to rise and fall in cycles in these places but value appreciation has been the strongest in these markets in recent years, the author said.