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Will the tsunami of foreclosures hit? Print E-mail
Friday, 25 August 2006

Experts anticipate a wave of foreclosures by Americans with millions of adjustable-rate mortgages. 

This fall the adjustable-rate mortgages (ARMs) will be reset, and many homeowners will see their monthly mortgage payments go up by as much as 20%.  This is the highest ever financed mortgage according to the Mortgage Bankers Association where ARMs are 36% financed in 2005. 

This is a matter of concern because ARMs are typically initially made at a lower rate.  As interest rates increase, mortgage payments increase. Between $400 billion and $500 billion in ARMs are due to be reset by the end of 2006. The following year will be even more dramatic, when more than $1.5 trillion will be reset.

This is scary for many Americans. Everyone who took out an ARM or another equally appealing low-rate mortgage over the past few years to buy a house, at times beyond their means, knew that someday their payments could balloon. But now, many of them are finding themselves stuck in a house they may soon no longer be able to afford, and, as the real estate market peters out, there's little they can do about it..

But according to a new study by RealtyTrac, which publishes the nation's largest database of pre-foreclosure and foreclosure properties, the situation is not all that bad -- yet. In their survey of foreclosure rates in the 100 largest metropolitan statistical areas (MSAs) in the U.S., the second quarter of 2006 actually saw fewer foreclosures than in the first quarter.

"I think the findings of this report are a message that people should take a deep breath and stop hyperventilating," says Rick Sharga, RealtyTrac's vice president of marketing. "The feared tsunami of foreclosures isn't taking effect yet."  But Sharga also predicts that the third and fourth quarters are going to be much worse. "Year-to-date, we have seen a 39% increase in foreclosures over last year," he says. "I'd be very surprised to see the rate drop below that, especially with the 3/1 and 5/1 ARMs resetting in the fall."

A 3/1 ARM has a fixed interest rate for the first three years, and thereafter adjusts each year. A 5/1 ARM is fixed for the first five years and then resets. A major concern is that the number of ARMs issued at subprime rates to borrowers with lower credit ratings is not known. "We know that ARMs default at a higher rate than fixed, and subprimes default at higher rates than primes," says Sharga. "Never have so many ARMs reset at the same time. There is no precedent for it."

Many industry observers are concerned that the default rate could reach dangerous economic proportions. Government-sponsored enterprises (GSEs), such as Fannie Mae and Freddie Mac, as well as lenders such as Countrywide Financial and Wells Fargo, are all looking at foreclosure-prevention strategies, according to Sharga. "The GSEs and lenders are developing novel solutions on workout programs to prevent people from going into foreclosure," he says. "Because if the number of foreclosures is too great, it drives down the market and they find themselves stuck with a lot of depreciating property on their hands. It is much more in their interest to educate homeowners on what their options are and come up with ways to help them keep their homes."

While many Americans will almost certainly find themselves in foreclosure, for others this could represent an opportunity that had been denied them in recent years, as prices climbed around the country. It's important to note that foreclosure laws are not federal, and so each state, as well as the District of Columbia, is different. In New York, homeowners have 455 days between the time they're delinquent on their loans and the time a lender can foreclose. In Texas, this pre-foreclosure period is 27 days, the shortest in the U.S.


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