I have blogged about “different ways for a busted refinancing plan” back in 2006 at the height of housing market. I argued that once the housing markets fall, most of the real estate “investors” will NOT be able to refinance out of their payment troubles. It was very clear to me that a housing Ponzi scheme simply cannot last forever, and was destined to pop. Of course, according to Greenspan, Bernanke, Wallstreet, and traditional news media, nobody could have seen the financial crisis coming.

I definitely thought that things would be worse in the housing markets. Due to various factors that I didn’t forsee, including Obama’s home affordability programs, delays in foreclosure processes by banks, and a dramatic drop in the interest rate curve, things are not terrible as of now. In fact, in 2009, housing markets actually went up (at least in California), sucking in the last bunch of ever-hopeful real estate “investors”. Regardless, numbers won’t lie, and let’s see how the negative amortization or option ARM homebuyers are doing.

Below is a summary from the monthly payment history based on a hypothetical case that I’ve made up for a California home ($500K, 20% down). I think it is pretty representative. You can get the original complete Excel spreadsheet here. All the interest rate data are from X-mortgage. I’m listing both MTA and COFI indexes which are the two most common indexes for option ARM:

Date	MTA (%)	11th District COFI (%)	Monthly payment (MTA)	Balance (MTA)	Monthly payment (COFI)	Balance (COFI)
2004	1.2383	1.802	1,286.56	400,042.88	1,286.56	400,230.78
2005	2.5042	2.515	1,383.05	402,760.80	1,383.05	403,981.61
2006	4.1425	3.759	1,486.78	410,981.87	1,486.78	411,293.82
2007	5.0292	4.224	1,598.29	424,437.96	1,598.29	422,556.80
2008	3.5283	3.111	1,718.16	436,514.40	1,718.16	432,092.15
2009	1.34	1.38	2,332.69	436,960.64	2,325.33	433,770.30

From the original teaser payment of $1286.56, the payment increased 7.5% annually, and is recast to about $2200 after 5 years from 2004. I think the more aggressive homebuyers who couldn’t cover the annual payment increase of 7.5% would have dropped out already. They either
1. sold and made some profits,
2. refinanced into another option ARM before housing markets dropped in 2007 (which will cause more problems later in 2012),
3. or defaulted already.
The more “conservative” homebuyers who were able to sustain thru 4 years of annual payment increases of a total of 30%, now will be facing an additional payment shock of 28% from $1718.16 to $2200. That is a total increase of 71% from the original $1286.56.

Needless to say, an increase of 71% in 5 years will be huge for anyone. Very few family will be able to make it thru a combination of salary increase, second job, and/or having non-working spouse going back to workforce. Unfortunately, refinancing to 30-years loan at today’s 4.75% will not be an option either, since the monthly payment for 30-years is about $2200, the same as the recast option ARM loan, if not more. I originally thought that these people probably would have problems with LTV or loan-to-value ratio. But Obama’s home affordability program has “solved” the LTV problems for these most of these homeowners. The monthly payment issue is still there. One cannot make an unaffordable home in the first place to be affordable.

Looking forward next year, once the home affordability program expires in mid-2010, we will probably get more defaults and walkaways from homes. Due to Bernanke’s cutting of interest rate, and a huge buying program in both treasury and mortgage market, current interest rates are temporarily held down. If the option ARM indexes like MTA and COFI rise up to 3% for example, the monthly adjustable payment will go up by another 25% to 30%. I don’t think the housing markets will recover anytime soon due to this impending supply of homes (from defaults of the option ARM loans).

So what should you do if you are one of the option ARM homeowners? There are many sites & articles that talks about foreclosure options. In my opinion, short sale would be the best choice (if you have this choice), since you won’t be liable for the deficiency judgment, and it will hurt your credit report the least. The second best choice is loan modification, although not many can negotiate a good deal with banks. The rest of the choices such as foreclosures are not ideal, but it’s probably earlier the better under the assumption that it does not affect your job prospects based on a much worse credit report.

Here is some of good sites & articles that I’ve found on foreclosure-related options. Some of the site owners are very helpful, and may be able to provide you with needed advice or services:

• Foreclosure option networtk. Hanna was particularly helpful to me on a couple of nasty legal questions.
• Foreclosure options from MSN
• More info on various foreclosure options from foreclosure university.

Here is just some decision flowchart on what I think you should do for your home/mortgages in many circumstances. It’s based on my personal opinion, and you should always consult professionals & legals when it applies. There aren’t many solutions for you besides out-right sale, short sale, refinancing, loan modification, foreclosures, and walkaways. But you should choose carefully on each option. Anytime you choose short sale, foreclosure, and walkways, it’s implicit that you will lose all the amount of any down payment that you have put into the home when you first bought it.

1. Case #1: if you are “underwater”, meaning that your loan amount is greater than your home market value, your decisions should be dependent on your loan type.
   1. Case #1A: if your loan was a PURCHASE loan, meaning that you have never refinanced your loan since your home purchase, in many states such as California, where there are laws protecting home buyers from loss of incomes or jobs, you should probably walk away from your home. In such cases, you should be protected by state laws, and you should not be responsible for lenders’ loss. The laws however cannot protect you if you have lied about your income and assets on your loan application. Please make sure that you consult lawyers for specific details, because I cannot be responsible for your legal troubles. Please NOTE that if you have a second loan, but the second loan was a purchase loan which you’ve probably paid PMI insurance on, you should still be okay. However, the same does NOT apply to home equity or piggy-back loan. Home equity loans are recourse loans, and it means that banks can theoretically or legally hunt you down, extract all of your current assets and future salaries, until you file bankruptcy.
   2. Case #1B: if you have more than one loan, and the second loan is home equity loan, you should probably try a short sale first, and then try doing a loan modification. The short sale is better in the sense that your credit is just partially ruined. The banks need to take their deserved losses. If you cannot do a short sale, you should try to modify your loan thru Obama’s home affordability program. With this method, I believe that your credit profile stays the same. However, you’re stuck with your own losses, banks get off the hook, and taxpayers may be stuck with your losses if later down the road, you walk away.

   For both of Case #1A or #1B, you may want to stop or slow down on paying your first loan or the purchase loan, so that you can force bank to come to the negotiation table with you. However, you will be risking a real foreclosure. Also, in case #1B, you should continue paying down your home equity loan regularly because it’s a recourse loan.

   3. Case #1C: if you have refinanced your home loans, then you’re out of luck. Legally, you’re 100% responsible for your loans. Nevertheless, you should try contacting banks for short sales, and doing loan modifications, like in Case #1B. Both will be to your advantages, if they go through.
2. Case #2: if you are at about the same the “water level”, meaning that your loan amount is about the same as your home market value, you should in general try to refinance, and/or short sale if you decide that you don’t want to keep your home.
   1. Case #2A: If the prevailing rent is still higher than your home cost: mortgage payment after tax benefits, plus any property tax, or potential interest credits, then you could try wait out the downturn (although I think the downturn will be much longer than anyone expects). You should at least try refinancing and see if you can lower your monthly cost. The Obama’s home affordability program will allow refinancing of up to 105% of your home value, if your mortgages are owned by Fannie Mae or Freddie Mac. You can check that at the home affordability page.
   2. Case #2B: If the prevailing rent is lower than your home cost, I think you should try to do a short sale, and forget about doing any refinance. Your short sale will be easier to go through bankers. And this way, it will prevent you from suffering further home losses down the road.
3. Case #3: if you still have substantial equities in your home, meaning that your loan amount is smaller than your home value, you are financially sound. I would advise to do refinancing through the normal channels, cash out any equities that you can, and hold on to your cash in 5-year US treasury for another two to three years for better opportunities. The best refinancing time is either now or possibly in Oct/Nov if stock markets take a dive at that time.

Here is the Obama’s home affordability page, in case you don’t know about it. If you follow thru the links, you can find out how to verify that your loans are owned by Fannie Mae or Freddie Mac.

And for potential new home buyers, my advice stay the same: just stay put and wait for year 2012. Your patience should be rewarded (in my opinion). That $10,000 home buying tax credit cannot come close to the amount that you may gain through further home value erosion.

Mortgage rates have gone up quite a lot along with the fall in bonds. The rates have been rising across the board (by almost 0.75% now).

I cannot understand who is selling the bonds, along with $US rising (just a little bit). This is truly a weird combination. Where is the money going?

The only sensible scenario that I can come up with is that Fed is lending all the financial institutions treasury bonds on its book in exchange of toxic mortgage bonds. The financial institutions are selling the treasury bonds in exchange for cash right away to resolve their credit crunch to satisfy cash demands from customers or depositors. Since all the transactions are domestic, $US exchange rate is not affected much. In effect, Fed is indirectly creating these new cash through these financial institutions, and supporting the solvency and liquidity of the financial institutions.

Still, eventually (or immediately) these new cash will find a new home. Apparently, they have blown up the commodity prices.

Fed is obviously trying to prevent housing deflation. Apparently, they have opted to save the greedy bankers and brokerage houses, and dumped the homeowners. To bring down the mortgage rates, Fed should actually buy up treasury bonds and/or mortgage bonds. Reducing the supply of bonds will increase its price, and therefore reduce the yields. Of course, such monetization effort will result in the immediate increase of cash circulation.

I guess Mish’s deflationary thesis has been right on. Cash is in demand. Not bonds, not stocks, not gold (yet) either. Before cash becomes trash, cash is still king. But I don’t think Fed has any ways out of this mess, besides trashing US dollar (or cash).

Bill Cara recently opined that maybe he had missed the first part of the trade of generation, which is to short the bond. I myself have also been a little surprised too.

The recent bond market actions have not been good at all. Whenever stock market falls, bonds tend to rise. But NOT this time. Stocks fell, and bonds fell too. While it is still too early to tell based on just a few days of trading, the trends seemed to be broken already.

Here is the chart for the 30-year treasury bond:

As you can see above, long term interest rates have risen. And with the recent tumbling of stock markets, the yields break new high instead of falling back down. Whatever it is I think for the intermediate term, the yields are probably going up. And that probably means more selling in the bond markets, which probably means that $US will continue to face pressure in the future.

If you want to refinance, probably you should look to lock your interest rates whenever the rates dip again (if it dips at all). I am also referring people to my own mortgage broker, so that you can get $100 cash back in addition to matching the really good rates at www.absolutemortgageco.com. If you are interested in getting a loan, you can email me, and I can forward you the details on the broker.

Certainly I think the best time to refi or getting a loan may be behind us. The implication from the rising interest rates for housing markets is obviously negative.

Actually it’s a little too late, but better late than never.

I will be doing a refinance. My previous loan is a zero-cost loan, meaning that it’s a no-point no-fee nothing-out-of-my-pocket and nothing-added-to-my-loan-balance loan. I paid a slightly higher interest rate, but I think it was worth it.

Anybody who wants to refinance or get a loan along with me, just send me an email at 1stMillionAt33#gmail.com (replace # by @). I think I can collectively bargain a cashback of about $50 to $100 for everyone with the mortgage brokers.

If you are interested, please MAKE SURE you put the subject in your email as “home loan for XXX state”, where xxx is the state that you live in. In the email, please put your first name, a phone number, the loan amount, and the loan terms that you are interested in. If your credit is not that good, please state so. If you know your loan-to-value (LTV) ratio is more than 70%, please state your LTV also. Obviously, I will only give this information to one single mortgage broker/company, and not anyone else. Your privacy will be guarded to my best effort. For the state of California, I already have several mortgage companies in mind. But I can’t promise anything yet for people outside of California.

I think stock markets may go for another dive in March, which means that the mortgage interest rates will be low again. You should be in time to catch and lock in that rate.

Regards.

Frugal at My 1st Million At 33 .com

The Hope Now Alliance is going to freeze the rates on ARM loans instead of letting them reset. That is absolutely unfair to anyone who doesn’t benefit from such deals. Why don’t I get some free points to buy down the interest rate, paid by the alliance too? Of course, if they can get all the investors in different trenches to agree, then I have nothing to say.

In any case, the banks are desperately trying to keep the mortgage losses under cover by whatever means. This freeze of ARM rates will definitely postpone the reckoning day. I originally expect a heavy down year in 2008/2009 for real estate prices. Now I am less sure of such. However, home prices definitely won’t be going up in 2008/2009. Lending standards for new loans are still tight.

One thing that I’m most curious of on the details of the freezing plan is that on all these ARMs, there are both payment and interest rates. When the payment rate is less than the interest rate, the loan is negatively amortized. I really wonder whether they plan to freeze both payment and interest rates, or just the payment rate. My initial guess would be that it would simply the payment rate that will be frozen. In that case, no one involved will take an actual accounting loss. The interest money will continue to pile up, despite the fact that those interest money may never get paid by the subprime homeowners. Obviously, if given long enough time (and a good amount of inflation), eventually home value will exceed and allow the paid off of these interest money. However, for these mortgage investors, they are still at the losing end of the stick. The inflation will eat away any of their recovery of the interest money.

If anyone knows somebody who get into such plan, please ask him and let me know that whether both interest and payment rates are frozen. Thanks in advance.

I assume that such modified loans will still be un-transactionable, or illiquid. No one in their right mind will buy such products. But keeping these loans away from foreclosure will prevent the banks to liquidate the homes and assigned the final value to the loan at loss. And so the fairy tales will go on, and the losses can be slowly written off. Banks can then “properly” meet the capital requirement ratio from FDIC.

Did anybody who read my blog got into this world-record breaking hedge fund which returned 10X in 1 year? I got the performance number from Minyanville’s article on 1000% Subprime contained. Boy, I only wish I had more cash/money to be brave enough to take a piece of that action. If I did, I would have almost doubled my net worth (since minimum investment was $100K). Unfortunately, I didn’t. But did you?

Certainly, somebody inquired him from reading my blog. Because I was asked by the fund manager Andrew Lahde to removed the proprietary PDF file, even though I had every good intention of promoting his business.

Well, I’m sure he and his clients made out like a bandit. 10X return in one year. That’s probably good enough for the next 10 year.

Were you that lucky? I guess rich does get richer, and I just needed to be a little richer to be in the league to participate and play.

Government has been pushing lenders to work out terms with the homeowners by modifying the loan terms. However, only 1% or less of the loans were modified. It is not happening for several reasons:

1. Work load on modifying the loan term is additional on a shrinking workforce in mortgage industry.
2. Most of the loans have been sold to different investors, and to modify one loan, you must get all the investors to agree to a loss on the mortgage bond (while homeowners get the gain).
3. Who is going to want to take the loss?

Congress has also passed a law to help out these “poor” homeowners (not sure if all the renters want to cry out FOUL). The forgiven debt by lenders to the homeowners from the “short sale” of the home, normally counts as a taxable ordinary income, will no longer be counted as income, and therefore, tax will not need to be paid.

However, I don’t think Wallstreet and Congress understand the magnitude of the credit crunch. In one sentence, the biggest credit and housing bubble in the human history has BURSTED. It just can’t be reversed anymore. In the capitalism (which tends to generate BIG up and BIG down), the mortgage bond market went crazily up, and now it is simply imploding. Many of the loan products can no longer exist, or at least exist in the same prevalence as before, simply because such loans cannot be sold to investors anymore, who are sitting on a huge loss, and are the main losers in this credit/housing implosion. Definitely homeowners are not the biggest losers. Mortgage bond investors are.

The following quote from FDIC head shows the ignorance of our government officials:

…most likely affect loans that have a low starter rate for two or three years and reset to much higher rates. Many of those loans are adjusting now and have helped push a record number of homeowners into the foreclosure process.

“Keep it at the starter rate,” Ms. Bair said at the Clayton Annual Investor Conference. “Convert it into a fixed rate. Make it permanent. And get on with it.”

Ms. Bair and other federal regulators likely couldn’t force servicers to make these changes, but her message might be interpreted as a warning to loan servicers about potential legislation, said Howard Glaser, an industry consultant based in Washington.

[Boldface, my emphasis]

Now, tell me, if the loan is kept at the starter rate, who is going to keep that loan on their book, since obviously such loans cannot be sold anymore most likely. Ms. Bair, do you want to volunteer and put up your own money to invest in these speculating homeowners?

At the end of the day, it is still about money. Only those loans that make sense to be modified with a minimal loss will be modified. And if the government make laws to force loan term conversion, expect more capital flight out of this increasingly capital-unfriendly country. If I were the investors, I will sell everything when the government force me to eat a substantial losses on my mortgage bond investment and hand it over to the homeowners.

But given the precedence in the oil industry where government repeatedly threaten big oil companies for additional taxes, I suppose that such scenario is definitely a possibility.

At this time of home prices falling, and possibly not being able to roll over/refinance the home loan, it is important to revisit this older post of mine: Deficiency Judgment: Think Again Before You Walk Away from last year

To the current homeowners: think again before you send the keys to the bank and walk away from the house. Do you think that when the housing prices fall, you can simply walk away from all the loans? Well, if you didn’t know, I am going to explain it to you. There are loans that you can walk away, and there are loans that you cannot. It’s called a recourse or a non-recourse loan.

A non-recourse loan means that there is no other recourse available to the lenders besides taking back the home. A typical non-recourse loan is a home loan for purchase. If the house falls below the balance of the purchase loan, the buyer can walk away from the house without any serious consequences (maybe except a big blemish on the credit report). On the other hand, a recourse loan means that the homeowner is personally liable for any “deficiency” when the lenders cannot recover the loan amount by selling off the house. A typical recourse loan is a home equity loan or a line of credit from home equity. As far as I could research, I don’t think a refinanced home loan is definitely a recourse loan. But I’m almost certain that a cash-out refinanced loan is recourse loan. As far as the legal language is concerned, a refinanced loan obviously is not a loan made for purchase.

…Click to read more….

Again chances of judicial foreclosures are “usually” small. But you just don’t know what a badly hurt banker will do with a mounting losses on his back, especially with more and more home loan defaults. If it means that it will reduce his losses, he might as well create an off-the-book company to specially deal with lengthy foreclosure process with more money recovered.

As the credit risk increases at all spectrum, and more lenders going out of business, guess what? You and I will be paying much higher interest rates.

I just checked out the mortgage rates offered by the two cheapest mortgage sources that I relied on (only for quoting purpose):
Mtgcapital.com: 15 years fixed at 6.000%, 30 years fixed at 6.375%. Lender’s fee is $1250.
Absolute Mortgage: 15 years fixed at 6.125%, 30 years fixed at 6.375%. Lender’s fee is $399, and both are zero points.
The above rate is based on ^TNX or 10 year treasury at 4.77%, and ^TYX or 30 year treasury at 4.92%.

You won’t find out the effects of increased risk premium + decreased competitions if you don’t have a history. Fortunately, I had a previous post with the exact information that I need:

at Mortgage Capital.com:
1. 30 years fixed: 5.75% APR.
2. 15 years fixed: 5.5% APR.

Both are zero points, $1250 lender’s fee.

at Absolute Mortgage:
1. 30 years fixed: 5.75% APR.
2. 15 years fixed: 5.5% APR.

Both are 0.125 points, $399 lender’s fee (lower interest and/or lower fees). When you make a loan as big as 680K (exceeding conventional conforming loan of $417K already), the 0.125 point will cost you more fees compared to MtgCapital. Therefore, Absolute Mortgage should be cheaper in all cases.

The above rates are quoted when 10 year treasury yield was at 4.509% and 30 year treasury was at 4.65%

So let’s see how much more expensive you need to pay now. From mtgcapital.com, it appears that every 0.50 point will give you 1/8 lower in interest rate. I’m going to use that to adjust the interest rates wherever applicable. The 10 year treasury was 0.261% lower and 30 year treasury was 0.27% lower.

So at mtgcapital.com, the 15 years fixed is now (6.00% – 5.5% – 0.261%) = 0.239% more expensive. The 30 years fixed is now (6.375% – 5.75% – 0.27%) = 0.355% more expensive.

At absolute mortgage, the 15 years fixed is now (6.125% – 5.5% – 0.261% – 1/8% * 0.125/0.5) = 0.333% more expensive. The 30 years fixed is now (6.375% – 5.75% – 0.27% – 1/8% * 0.125/0.5) = 0.352% more expensive.

Conclusion: you and I will be paying about 0.25% to 0.35% more in interest rate for the same loan as before. On the 30 years, the risk premium is higher now also because there is a yield curve steepening effect. If Fed starts to cut interest rates, it may pin down the lower end of the curve, but the longer end (15 and 30 years fixed) may or may not come down in relative terms. Until the inflation appears subdued, the longer end will not come down as much.

Good luck to anyone who wants to get a loan, or refinance their ARM time bomb.