The Mortgage Meltdown Could Get Messier
Article by dane
Foreclosure, a word rarely heard in the media before 2007, is now a term used almost daily in the news. Millions of Americans are losing their homes as the country falls deeper into recession. The bailout enacted by congress in October has done little to stop the flow of foreclosures, which are up 30% overall from last year.
Many financial analysts believe we are near the bottom and the recession should be over by the end of 2009. However, as reported on 60 Minutes, the outlook may not be that rosy. The real estate debacle is often called the “sub-prime mess,” referring to all the mortgages given to home buyers with risky credit worthiness. According to Whitney Tilson, an investment fund manager, there are a whole slew of other risky loans out there that are just now heading toward danger.
He is referring to two types of loans known as Alt-A and option ARM. According to the Federal Reserve website, Alt-A, which is short for “alternative paper,” are mortgage loans that were considered less risky than sub-prime loans. The interest rates on these loans are determined by credit risk and run between prime and sub-prime rates.
An adjustable rate mortgage, or ARM, is just what it sounds like. The interest rate on these mortgage loans adjust after an introductory rate that is quite low, sometimes as low as 1%. These “teaser rates” are reset based on an index and can dramatically change the amount of a monthly mortgage payment. Borrowers were told the interest rate could even go down, but that has not been the case.
Tilson did research on these types of loans in 2007 and was shocked at his findings. These two types of loans, although considered to be less risky just a few years ago, pose great potential for financial disaster. “It was data we’d never seen before and that’s what made us realize, ‘Holy cow, things are gonna be much worse than anyone anticipates,'” Tilson said.
As the economy continues to unravel and the rates on these loans begin to reset, the ripple effect could be devastating. Like the sub-prime loans, Alt-A and option ARM’s have been bundled into what are called mortgage-backed securities. These complicated investment packages, which are traded on Wall Street, are largely responsible for the market free-fall of the last several months.
While Austin has a much lower foreclosure rate than other parts of the country, the Alt-A and option ARM’s were popular lending tools in areas experiencing the condo building boom like southern Florida. The fear is that other growth areas, like Texas, have yet to feel the full effect of the real estate troubles. As these loans are due to adjust to new rates over the next few months, the number of foreclosures could sky-rocket.
The Wall Street bailout has yet to lessen the burden on the average American by loosening credit to help move the economy out of a recession. If Tilson is right, the months ahead could be even tougher. As the new administration makes moves to take over and help the ailing economy, the hope is that more emphasis will be put on changing the terms of these loans that are headed to foreclosure.
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