Recasting Mortgages Worth $47 Billion Will Increase Defaults

Written by: Steve Cook   Mon, January 11, 2010 Beyond Today’s News, Foreclosure Situation

Thousands of homeowners who have been making payments on interest only mortgages are in for a rude shock this year. Their monthly payments are about to rise 15 percent on average, forcing many into default and foreclosure.

 Fitch Ratings today forecast that $47 billion worth of prime and Alt-A Interest only loans are due to recast this year to require full principal and interest payments, placing additional stress on U.S. homeowners. 

 Over the next two years, a total of $80 billion of prime and Alt-A loans, and a total of $50 billion Subprime loans are due to recast.

 According to Managing Director Roelof Slump,”60-day delinquency  rates have rise over 250 percent in the 12 months following previous recasts  for prime and Alt-A loans.”

 Recasts typically have a significant impact on loan performance. While

only 3.3% of prime loans are 60 or more days delinquent prior to recast, delinquencies the year after recast increased to 9.3%. Similar effects have been seen in Alt-A and subprime, with delinquencies increasing from 12 percent to 29 percent for Alt-A, and from 20 percent to 58 percent for subprime loans.

 Furthermore, ‘declining borrower equity is still eroding refinancing opportunities and incentives to continue payment,’ said Slump. On average, current loan-to-value (LTV) ratios for prime and Alt-A loans are 118 percent, with 64 percent of borrowers having negative equity.

 The effect of higher expected defaults on interest-only loans figures to be relatively small on the overall market since these loans account for only 8 percent of the securitized non-agency market. However, there is significant performance risk in residential mortgage-backed securities transactions with high concentration of interest only loans, particularly if a large portion of loans recast around the same time. It was not uncommon to see IO concentrations of greater than 50 percent in certain securitizations. Performance on these pools will be particularly hard-hit by recasts.

Fixed-rate interest-only borrowers only face a payment increase equal to an amount of principal amortization when the interest-only period ends, with the payment staying  fixed  thereafter  for  the life of the loan. Adjustable rate (ARM) interest-only loans also have interest rate risk, where the payment can increase based on prevailing interest rates at the reset date. In today’s environment, ARM IOs will only face a  payment increase from principal amortization when the IO period  ends.

However, ‘if rates rise on subsequent reset dates, so will the monthly payments,’ said Slump.

Most outstanding IO loans are ARMs, as many borrowers combined these features to provide for the lowest initial payments. Of those IO loans recasting in the next two years, 99 percent of prime, 94 percent of Alt-A, and 90 percent of subprime are ARM loans.

Furthermore, borrowers were often qualified for loans on their ability to make initial IO payments rather than the full principal and interest (P&I) payment to which their loan would adjust, and on 63 percent of Prime and Alt-A loans, this qualification was made with less than full documentation of income.

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