My 1st Million At 33 - yes, you can do it too

Allowing refinancing of Option ARM and interest-only ARM is the modern days of the Ponzi pyramid scheme. As long as some stupid Asian central bankers are willing to keep rolling over the loans, the big spenders in America can continue to live in paradise of ever increasing liquidity.

Most of these kinds of exotic ARMs started in 2002/2003, and really took steam in 2004/2005. The current calm before the big storm is due to the standard 5 year period before these ARM loans get recast into the rest of the 25-years amortization schedule. A recast of option ARM or interest-only loans mean that the payment of the loan is fully re-adjusted without subjecting to any max annual cap increase (usually 7.5%) to make sure the loan will be repaid in the rest of the years in the loan term. Well, like it really matters, if homeowners can just refinance into another option ARM, packaged into securitized “asset”-back bond products, and sold (and hid) in wholesale to another stupid investor who is hungry for “safe” and slightly higher yields.

Here is a partial table of a hypothetical case on option ARM re-payments. The payment shock is shown near the end of the table.

Obviously, I don’t think it is likely that anyone can meet such increase in payment, unless their wives go back to work and get high salaries (if not already). The key to whether the homeowners can refi their ways out lies in the credit market in 2008/2009 timeframe. If the lending standard tightens, or the credit market tightens later and force the interest rate spread to get much bigger for lower credit trenches, these homeowners will be looking at only one solution out - sell the home, possibly with a loss, or even come up with additional cash to settle the sale.

Increasingly, these lax lenders are eating their own dirt now. Ever heard of early payment default? How can a mortgage default in 2 or 3 months?! There can be only two reasons: either the loan was a fraud, or the loan shouldn’t be made at all to someone who cannot repay. In either cases, lenders simply have not done their due diligence to check the financial backgrounds of the borrowers. They totally deserved buying back those packaged loans and take losses.

All of the above payment calculations can be found and downloaded in this Excel spreadsheet. The spreadsheet also has the calculation for 3/27 and 5/25 ARM loans for my last article on The Duel of ARM Reset Vs Re-refinancing.