Signs That Foreclosures May Be Peaking

by: Kathy Lien April 09, 2008    

Kathy Lien

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As traders we know that when Main Street latches onto something, it usually means the top. Growing foreclosures have been one of the biggest concerns of Wall Street and with real estate brokerages now giving Foreclosure Bus Tours, it leads us to wonder whether foreclosures have hit a peak.

According to the following ARM schedule published by Deutsche Bank, resets of Adjustable Rate Mortgages are expected to reach a peak in 2008. (Click images to enlarge.)

However the Federal Reserve has already cut interest rates by 200bp, which means that the interest rates that these mortgages will reset at could actually be the same or lower. According to my friend Mike Shedlock:

“Most of the 5/1 ARM’s I reviewed that originated in 2003 had start rates between 4% and 5.125%.”

“3-1 LIBOR based ARMs initiated in 2005-2006 would also likely reset lower and again with the same caveat repeated about day-to-day conditions, lender specific conditions, etc.”

ARMs are based on an index rate, typically 1-year treasuries or 1-year LIBOR, plus a margin amount (e.g. the treasury rate + 2.75%).

Current rates as of April 8 are:
1 Year LIBOR 2.60
1 Year US Treasury 1.68

Taking the high interest rate of the mortgages initiated in 2003 (which are the ones set to be reset in 2008), the reset rates should range from 4.43 to 5.38%, only slightly higher than 2003 levels,

A glance at this Denver neighborhood indicates that those who are vulnerable to foreclosure may actually already be in foreclosure. Although I still expect more homeowners to default, the rate of foreclosure growth should begin to slow as ARM resets are no longer as painful as they use to be, particularly if the Federal Reserve continues to cut interest rates.

Source: USA Today (Link to Denver Foreclosures)

Although I do not expect the US economy or the housing market to begin to recover until the fourth quarter, an improvement in the pace of foreclosure growth could be the first step towards a recovery.

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This article has 24 comments:

  •  
    Apr 09 05:18 PM
    Won't the leveling off of mortgage rates be counter-balanced by the contraction in bank lending? Maybe that's just too simplistic, but it seems like that to me.
    Reply | Link to Comment
  •  
    Apr 09 05:20 PM
    Historically, median house prices have been = to 3X median income. Currently, many U.S. cities have median house prices that are 6X-10X median income. There is no incentive for young people to buy a house anymore, they're much better off paying $1200/month for rent than paying $5000/month for a mortgage in which the asset is declining in value.

    Babyboomer spending is supposed to peak in 2009. Who is left to support these inflated house prices after their spending declines?

    The best, fastest way to solve this bubble is to allow these houses to QUICKLY decline to about half their value or inflate workers wages by 2X, otherwise our economy is stagnant for the next decade.
    M3 inflation which is running at about 16%/year could force huge wage increases...

    No matter what those investor analysts say on CNBC, this housing crisis is going to be around for quite a while, profits from most investments will be low for some time.
    Reply | Link to Comment
  •  
    Apr 09 05:24 PM
    I believe you focus on resets a little too much. How about the chunk of sales from 05-07 that were interest only. Reseting the interest rate one percent lower will not make up for the fact that it is time to start paying off principal with your mortgage checks.

    Furthermore, paying a lower interest rate on a house that has dropped in value 20% is no saving grace. That's like having an accident in your pants and being happy becuase it does not smell that bad.

    As for the picture above, I would figure that foreclosures would happen in bunches as communities were sold as they were built, this one above might have been sold three or four years ago. I figure that if we showed a community that was built in 2007 there would be fewer red houses but in a year it would look just like the picture above. (How did the lower left corner section of that develpment get so lucky and have only one foreclosure? I bet everyone in the community hates them.)

    Dreaming that foreclosures are near the bottom or that housing will rebound in the fourth quarter is just that, a dream. This goes against all the evidence out there and even against what the actual home builders are saying.

    Reply | Link to Comment
  •  
    Apr 09 05:34 PM
    I agree with drmalaka. You also need to remember that interest rates will move up quickly as the economy begins to pick up speed. A 2.5% increase in someone's mortgage rate will translate into a 30% increase in their monthly payment. Also, housing prices lag into a recovery. Means that much higher house payments as the economy improves won't be followed by a rapid increase in values. Everybody tries to treat the housing market like the stock market; it is a slow moving beast, the foreclosures will be dripping on to the market for several years, keeping MBS investors skittish, credit tight, and consumer's miserable.
    Reply | Link to Comment
  •  
    Apr 09 05:47 PM
    From experience, I know that just because the Fed is cutting rates does not mean lower rates are trickling down the food chain to the consumer. Take a look at bloomberg and you'll see that fixed mortgage rates are about where they were last year despite the Fed cutting their target rate by more than half over the same time period. So to say that the Fed cutting rates will ameliorate the ARM reset pain flies in the face of what's really happening.
    Reply | Link to Comment
  •  
    Apr 09 05:52 PM
    While it may seem like a glimmer of hope for some resets to not tip the borrowers because of interest rate declines, the pressure of inventory on prices may start tipping borrowers into negative equity territory that makes foreclosure the best option. I'm sure someone could do some research to quantify these issues, but nobody in financial journalism apparently gets paid to crunch numbers the way the ivory tower guys would...
    Reply | Link to Comment
  •  
    Apr 09 06:01 PM
    I believe people have done research to see whether (negative) home equity levels or resets were more important to predicting defaults and foreclosures, and they all found that equity levels were much more important.
    Reply | Link to Comment
  •  
    Apr 09 06:24 PM
    We have just seen the tip of the iceberg for foreclosures. Housing prices will fall back to 2000 / 2001 levels before we bottom, there will probably be a brief time (time of panic / capitulation) that prices will drop to 1998 levels.
    Reply | Link to Comment
  •  
    Apr 09 06:31 PM
    Who among the detractors has statistics that show how far under the purchase price the value of the home has to be before "owners" stop paying? Realistically, once the owner moves in and starts paying, the value in year 2 won't change their outlook. It is merely their ability to pay, isn't it?
    Reply | Link to Comment
  •  
    Apr 09 06:45 PM
    fast one,

    You are absolutely correct in that comment: "Housing prices will fall back to 2000 / 2001 levels before we bottom, there will probably be a brief time (time of panic / capitulation) that prices will drop to 1998 levels."

    I plan on buying a house in Vegas, I'm waiting for those 2000 price levels to return, before I buy. House prices there are now half what they were in early 2005. 1/3 is not too far away.
    Reply | Link to Comment
  •  
    Apr 09 07:15 PM
    Maybe I don't get it, but isn't the problem ~ the fact that a lot of these low interest ARM's were given out to people with poor credit scores in the first place. What makes you think a bank will just reset these loans at the same rates when it is time to renew? If I was redoing a mortgage to a person with a questionable credit score I think I would want a higher rate to offset the increased risk.

    Right?
    Reply | Link to Comment
  •  
    Apr 09 08:13 PM
    If prices were held constant as well as employment (a typical economist perspective) I could understand that a reduction in arm resets would contribute to a decline in foreclosures. I would also grant that if reseting arm's were pegged at the same rate(are they allowed to go lower?) then it wouldn't matter how many are reseting there shouldn't be a foreclosure problem at all and again you would expect to see a decline in foreclosures. Yet the two assumptions are not holding up and may be in their own downward spirial. If job growth is slowing or in decline than a new source of foreclosures are people not being able to make their payments regardless of any resets(at higher or same rates). If the value of the homes are droping then again the likelihood of investors in negative equity situations higly increases the odds of them simply walking away. If we are indeed in a downward spiral pluging up the arm reset hole may not be sufficient to stop the negative feedback loop from continuing on its course. It reminds me more like a phsyics equation where the initial push to get the ball rolling may have been the arm reseting but as prices fall and jobs dry up due to less equity/borrowing/spend... feedbacks then the ball is continuing to roll down an ever steeper slope and more likely may accelerate as the slope continues to steepin with or without any more push from the arms reset.
    Reply | Link to Comment
  •  
    Apr 09 08:40 PM
    user 2lakes:
    The reason that banks will try to work them out (probably in vain) is that foreclosure process cost a lot more. The lawyer fee, cleanup, realtor/listing fee, property taxes for the duration. Typically it takes 9 months for a house to get re-listed after foreclosure. right now we have about 10 months of supply on the market. Add that together means 17months of no cash flow on top of all these costs.
    If it ends up a short sale, they might very well lose over half of the money they invested. It'd be better off to work it out and take a 20% loss instead.
    Reply | Link to Comment
  •  
    Apr 09 08:43 PM
    sorry, "relisted after foreclosure" should have been "relisted after initial missed payment."
    Reply | Link to Comment
  •  
    Apr 09 08:53 PM
    wishful thinking, people in suburban detroit are just beginning to wake up and realize that they are going to need to mark down there houses 25% from current values (mainly in there head as to what they think they deserve) if they want them to sell iygmd
    Reply | Link to Comment
  •  
    Apr 09 10:12 PM
    Way too many assumptions! Is this just based off of HSBC's portfolio? They came late to the party for one. Also most loans were interest only loans and many of those lose their low interest only option payments when at their first change so now the loan is fully ammortized to pay off in 28 or 27 or 25 years etc. That makes the payment much higher than if they had a 30-year normal loan, especially if they were used to paying the interest only payment.
    Reply | Link to Comment
  •  
    Apr 10 01:10 AM
    If main street latches onto an investment idea, doesn't that just mean that the price of that investment is near a peak? So are prices paid for foreclosures on their way down? Sounds good to me.
    Reply | Link to Comment
  •  
    Apr 10 01:15 AM
    Interesting idea Kathy except that according to the last study I saw on the subject, more than 50% of foreclosures were due to change in income or loss of job and less than 5% were due to mortgage rate resets...

    You don't examine the ratio of mortgages defaults due to rate resets leaving us all in the dark.
    Reply | Link to Comment
  •  
    Apr 10 04:41 AM
    Another point to consider - these defaults started occuring while the economy was still considered strong. They were a result of poor borrowing and lending decisions and a stall in the housing market. What effect is the current/impending recession going to have on the amount of foreclosures?
    Reply | Link to Comment
  •  
    Apr 10 11:19 AM
    I suspect the author is wrong.

    - I don't see loan rates dropping even after the large discounts from the Fed, or their easing of money. And, I don't see that the discount rate can come down much more anyway.

    - Lenders have 'increased' the required down payment from 20% to 25% in the hard hit areas.. These are the areas that need easier loans, not loans that are harder to get. And they are dis-allowing a lot of the maneuvering such as the seller lending back 10%, etc.

    - Every day brings more layoffs and business closures.

    - We are in a recession.

    - The Fed has stated simply that they can do little more to help.

    - Congress and our lame-duck President seem to be unable to achieve a real compromise, and even if they did, the legislation would be a bastardized non-functional effort.

    I believe Switzer ( Hope I pelled his name correctly ) who was on CNBC this morning and Professor Peter Morici ( read this guy's stuff - To bad he isn't running the Fed!..). They both state that we have a long way to go before we see the end of foreclosures and the financial mess. In fact Switzer expects another 20% drop in home values from the 10% we already have experienced. By the way.. That's a nation-wide drop...And does not in any way reflect the realities of the hard hit areas!

    Thx! jegan ;-/
    Reply | Link to Comment
  •  
    Apr 10 01:54 PM
    Were you alive, in 1955? No? Well, not to worry - - - 1955's home prices are coming back, to a neighborhood near you. You might want to listen to an oldie by Fats Domino, from that year, "Ain't That a Shame?", while you watch all that phoney-baloney increase in house prices fade into the soft evening shadows. So, what does this have to do with this article, you ask. Here's what: One of the biggest sham(e)s I have witnessed in my long life has been the real estate shell game. There never should have been dramatic increases in house-prices, in the first place. A house is a depreciating asset, in reality. The game is just about played out, now, though. Any asset is worth only what someone is willing, and ABLE to pay for it. The time is coming, and this trend will not be reversed, when the amounts buyers are both WILLING and ABLE to pay, for these millions of homes on the market will be a slender shadow of what it has been, until recently. At that point all the articles and opinions about foreclosures will be academic.
    Reply | Link to Comment
  •  
    Apr 10 08:38 PM
    I love an optimist! But I'm afraid I agree with most other posters here. To quote an ex President "It's the economy, stupid". Although I'm sure there were abuses out there the whole thing about arms has been overdone. No one was forced to make interest only payments. Who did they think was going to pay the principal? I heard Countrywide qualified on the interest only payment which was bad for everyone but unless they lied at application or had an economic catastrophe they could make a fully amortizing payment. Responding to Haydete: It's not a matter of how much equity loss there is, it's a matter of how strong their morals are. If you bought a big screen TV 3 years ago and now could get one for less than you still owe do you get a pass to walk away? Maybe the Feds will force Best Buy to reduce your balance to todays price.
    Reply | Link to Comment
  •  
    Apr 10 09:29 PM
    I agree with the article- Sub-prime mortgages 2/28 3/27 reset real high- because of the 5-8% margin that gets added to the reference rate- thus there is no escaping lower payments with these sub-prime loans. Quite predatory.

    This article is about ARM resets- Not new originations or refinancing. Lenders con't go back on an outstanding loan - demanding more that what was agreed upon on the mortgage note.

    However most of the sub-prime loans reset this year and will be gone by 2010. So we should see a peak in foreclosures from those loans after this year.

    Regarding the agency and near prime ARMS - these are mostly hybrids 3/1 and 5/1 mortgages which reset 2.75+ CMT (1yr) or 2.25 (1yr Libor)

    Before fed starting cutting rates - the CMT was around 5.25, thus ARMs would reset to 8% at those levels, given an initial fixed rate of 4/5-5/5% - that is a big jump.

    Now that the CMT is at 1.60, ARMs resetting today - rate would be 4.35% That would be a decrease for most all borrowers. To say the fed has not helped for ARM resets (excluding sub-prime) is incorrect statement.

    Resets on interest rates are determined at origination - the margin - the date - the reference index- only variable is the level of the index - CMT - Libor etc - which is calculated at time of reset.

    ARMs other than sub=prime she see payment decreases assuming CMT and Libor don't skyrocket.

    Prime home-builder or construction loans and HELOCs are the big trouble areas, as well as any investment property mortgages originated near zero down. Many of these may not be ARMS and borrowers don't face payment increases, rather they will walk due to being upside down, and not having any equity or skin in the game.
    Reply | Link to Comment
  •  
    Apr 13 12:01 PM
    the price of a new home should reflect the cost of labor, the cost of commodities (like copper), the size of the home and lot and the location, location, location. since commodities seem to be the factor that is changing the most, it should be relatively easy to determine the true value of a home.

    if the builder can still build one a few blocks away from yours for 80% of the price you are asking, you are asking too much. homes are not a depreciating asset in an economy where inflation is a concern. the more it costs to build, the more your home is worth. the less your dollar buys, the more your home will cost.

    the only other concern we have is the decreasing number of buyers as baby boomers disappear. that can be solved by annexing mexico. we get their oil. they buy the homes they helped build. win-win.
    Reply | Link to Comment
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