Monday, September 21, 2009

Option Arm loans in Bay Area - ugly

Of the 10 metro areas nationwide with the most option ARMs, three are in the Bay Area. They are the East Bay counties of Alameda and Contra Costa, the South Bay area of Santa Clara and San Benito counties, and the counties of San Francisco, Marin and San Mateo.

Together, these areas account for the second-most option ARMs in the country

Fitch said 94 percent of borrowers elected to make minimum payments only. The shortfall gets added to their loan balance, which is called negative amortization. The amount they owe can grow substantially.

After five years, or once the loan balance reaches a certain threshold above the original balance, the mortgages "recast" and borrowers must make full principal and interest payments spread over the loan's remaining life. Fitch said that new payments average 63 percent higher than the minimum payments, but could be more than double in some cases.

"When option ARMs recast, the payment shock is much more intense than we've seen (with other types of loans, such as subprime)," said Brown. "That makes them potentially much more damaging."

Unlike subprime loans, which were more commonly used for entry-level homes, option ARMs started out with high balances. In the five-county San Francisco area, option ARMs average about $584,000 and were used to buy homes averaging $823,000.

That means they'll spawn foreclosures among upper-end homes.

"The mid- to high-end real estate market is already stranded right now," "Any sort of extra inventory is not going to be welcome for that market whatsoever."

Option ARMs became widespread starting in 2005, which is why the recasts and higher payments will hit starting in 2010, five years later.

But now, on average, the amount these borrowers owe is 126 percent of their home's value, based on depreciation and not including the effects of negative amortization, Sirotic said.

That could explain the ominously high default rates. Even though most option ARMs have not yet adjusted higher, 27 percent of option ARM loans in the five-county San Francisco metro area are at least 90 days past due or in foreclosure.

The option ARM scenario will unfold over several years, which offers some hope that there may be time to avert a deluge of foreclosures. The bulk of option ARMs recast dates are spread out from 2010 through 2012. Especially for the loans that recast later, it's possible that a solution will arise, either through rising home prices allowing them to refinance, or through extra intervention from the government or lenders to help these borrowers.

"This will be another factor keeping home prices from recovering,"

From 2004 to 2008, almost one-fifth of all mortgages, for both home purchases and refinancing, in the San Francisco and San Jose metro areas were option ARMs - more than double the national average. Option ARMs were even more common in the suburban counties of Sonoma (25% of home loans) and Solano (28%). Though most option ARMs have not yet recast and hit borrowers with higher payments, they are going into default at extremely high rates. One quarter or more of all option ARMs in the regional areas are more than 60 days delinquent or already in foreclosure. Analysts say option ARM borrowers are so underwater that they may be choosing to walk away.