LIBOR Spike Not Only Hurts Suprime…Pay Options, Jumbo Prime, Alt-A Too

Posted on October 8th, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

Lets do some brainstorming folks.  Which lenders and loan programs will this impact the most…

A recent story came out highlighting how the LIBOR spike will hurt those in Subprime ARMs set to adjust. However, LIBOR was a choice for many Jumbo Prime and Alt-A loans such as 5/1, 7/1, 10/1 AMs and the now imfamous Pay Option ARM.

Arguably, given that Pay Option ARMs adjust monthly or quarterly in most cases, if LIBOR comes down quickly payments will roll back down with their respective index term value.  However, if LIBOR hangs up there this will borrowers will scream towards their maximum negative amortization allowance of 110%, 115% or 125% accelerating the time-line to the ‘Pay Option ARM Implosion.

There is more trouble. Other loan types that only adjust yearly such as the 5/1 Jumbo Prime or Alt-A resets the borrower in higher rates for an entire year.  Not only that, but many go from interest only to fully amortized.  Lastly, on the 5/1 product the first adjustment can be as high as 5% over the start rate.  Given the margin on these were between 2.25 and 3.25%, borrowers will get squeezed. Getting squeezed on a monthly payment when the value of your home is now a double-digit percentage less than the loan amount can turn the most ‘Prime’ of borrowers into subprime very quickly. 

Anyone have an idea on which banks or lenders offered 5/1 product with the highest margins over LIBOR from 03-04?  Lehman’s Aurora products come to mind first. Also, which lender’s Pay Option ARM offerings were primarily LIBOR based? Most lenders offered LIBOR and MTA but if my memory serves me, most chose the LIBOR Index on the false premise it was safer and because the rate/rebates were better/larger. -Best, Mr Mortgage 

Libor Rise to Boost Subprime ARM Defaults 10%, Citigroup Says  – By Jody Shenn

Oct. 7 (Bloomberg) — Increases in benchmark London interbank offered rates may boost homeowner defaults on resetting adjustable-rate mortgages, contributing to a “vicious cycle” in the credit crunch, according to Citigroup Inc.

-The Libor rate for overnight loans in dollars between banks rose 1.57 percentage point today to 3.94 percent, the British Bankers’ Association said.”

Among subprime loans, defaults may climb by 10 percent, analysts Rahul Parulekar, Udairam Bishnoi, Sumeet Kapurand Tanuj Garg wrote in a report yesterday. About $23.7 billion, or 87 percent, of the ARMs underlying bonds whose interest rates begin adjusting next month track Libor rates. Six-month dollar Libor has climbed to 4.02 percent, from 3 percent on Sept. 15.

The average subprime borrower facing an adjustable payment for the first time next month would face a monthly payment increase of about 18 percent based on Libor rates as of Sept. 30, rather than the 10 percent that would have occurred based on the rates on Sept. 15, the analysts wrote.

Mortgages Reset

About 121,000 mortgages will reset for the first time next month, according to the Citigroup report, which looked at only securitized mortgages. About 1.8 million loans have already begun adjusting based on benchmark rates, the report said, while 3.7 million face resets scheduled for after next month.

“Almost all” subprime and Alt-A ARMs with a few years of fixed rates, about 60 percent of those prime-jumbo mortgages and about 75 percent of such loans in Fannie Mae, Freddie Macand Ginnie Mae bonds are linked to Libor, the report said. The loans most often are pegged to six-month Libor.

23 Responses to “LIBOR Spike Not Only Hurts Suprime…Pay Options, Jumbo Prime, Alt-A Too”

  1. I have relatives who bought near the peak in October 2006 on the Bay Area peninsula with a 10-year IO mortgage (Mark or others — would this be a “10/1”?) With the help of a family gift, they put down 20%, and mortgaged $750k. Comps are now going for 10-15% less than what they paid. Yet they have no understanding or concern about their situation. Is this mortgage likely resetting once per year and then will have one recast at the end of the 10 years? Thanks.

  2. By the way, my relatives paid $572 / sqft, and now a neighbor’s house four doors down, and 20 years newer, is for sale asking $459 / sqft. Just using this as a guage, they are down approximately 19.7%.

  3. Tom,

    not saying that your sqf comparison total value isn’t correct, but I would be careful with comparing houses by $ per sqf. Having specialized in Historic homes for years, I’ve seen people trying to offer a brick ranch in a historic neighborhood full of victorian clapboard homes for sale, with the help of an appraisal based on sqf and number of bedrooms and baths. Sure, on the appraisal it may look the same, but a buyer in that area would always take a victorian first and the brick ranch would be someone settling for it. Houses can have the same sqf and number of bedrooms and baths, but have really totally different values on the ‘Real world’ market place – meaning what would a buyer pay for it? The layout, the size of the various rooms, the finishing materials, white walls vs custom colors, the location, high ceilings vs low ceilings, crown molding and…and…and. There are so many different variables that may influence the actual value, that a number per sqf is just theory in my opinion.

    Michaela

  4. Michaela, You likely bring up a valid point, though in this case, after being in the relative’s house and driving by the other one, I suspect they are very close comps (same view, same side of street, if anything, the one for sale is much nicer, and, as I said, 20 years newer…and it shows). If not a sq/ft measure, what would you suggest might be a better way to measure? Regards, Tom

  5. In my experience, most borrowers “chose” the MTA because it offered the highest YSP to brokers and loan officers. The MTA has actually plummeted, benefiting scores of borrowers who wound up with that index tied to their option arm.

    Tom, it sounds like your relatives took out a 10 year fixed mortgage with 10 year interest-only option, meaning it won’t have its first reset for 10 years, and they can make IO payments for the first ten years on the loan if they so choose. So they should be okay for a while.

  6. “If not a sq/ft measure, what would you suggest might be a better way to measure?”

    Tom,
    I wished I had a good answer for that. A few years ago I lived in the middle of zip code 30310 in Atlanta, which was the number one zip code for mortgage fraud in the U.S. at that time (2004/5). And all the groups working there were succeeding, because appraisals were all based on sqf, bedrooms and baths and minor variables.

    This was a historic neighborhood and let’s say a 2000sqf Victorian home, that was lovingly restored sold for 300K. So, now the scammers came and bought out all the rundown 2000sqf homes in the neighborhood. Paid 70-80k for them, put maybe 20k in. Then they got an appraisal on the same sqf and rooms like the ‘real restored sale’. On paper it looked like the same house. A lender in Chicago didn’t know any difference. Once that was dome a few times there were no real comps in the neighborhood, because every sale there was a mortgage fraud. A number of groups operated and they bought out all they could and kept doing this with straw buyers and those ‘fake’ appraisals.
    The appraisers didn’t lie (well, not much), the houses did have the actual 2000 sqf, 3 bedrooms, 2 baths just like the 1st real sale.

    And I kept seeing the same mortgage companies. I saw 1 house having been through mortgage fraud the year before with Aurora and then being sold to the same scammer again as REO and now financed with Lehman (same company) and now going through foreclosure again. I tried to notify some of the mortgage companies that kept being involved and they didn’t want to hear about it. I spent a lot of time researching and documenting every sale in that neighborhood and following all this scammers through all of their purchases, building up cases against them. yet, the mortgage companies didn’t care when I called them.

    Anyway, to make a long story short, having just a few criteria for the appraisals is what enabled a lot of people to do mortgage fraud.

  7. Tom, having been in the mortgage industry for several years I can with great confidence tell you that price per Sq ft is an unreliable way to measure anything real estate. This is in large part due to differing amenities within the property, different floor plans and different conditions of the properties being compared.

    Just a quick example would be the condition of a roof on two identical houses. One house had a brand new 30 year roof put on it the year before it went for sale and the second still has the original roof still on it at approximately 25 years old. You will certainly get more for the house with a brand new roof than you would with a 25 year old roof even though in all other ways the houses are identical.

    Another thing to keep in mind would be exactly how motivated or what position the seller of a house is in. If another home is for sale because of iminent forclosure or being sold on a short sale agreement then teh actual value of the house may be higher than what is being asked because teh sellers are not worrying about a profit but to just break even on thier current loan or simply get out of the loan no matter what in the case of a short sale.

    Right now there really isn’t any accurate way to value property correctly anymore. Even appraisers dont have a clue how to value property anymore.

    Now as far as the loan itself goes, yes they are in a 10/1 ARM with interest only. What this means is that at the end of the 10 year period, and having made only the interest only payment for that time the rate will adjust according to teh LIBOR rate (most likely) and will convert to a 20 year ARM with the payment increasing to payoff the ENTIRE principal in 20 years at what looks as though it will be a substantially higher interest rate. In other words, after teh 10 years of paying nothing but the interest on the loan at say 6.5% and an actual payment of $2,000 per month, thier rate could easily adjust to 10% fully amortized over 20 years and the payment could VERY easily double and even triple to between 4 and 6k per month. (just making up numbers here but I think you get my point)

    THier payments wont change for the entire 10 years that they are interest only but once that 10 years is up it will adjust once immediately and once per year therafter for the remaining duration of the loan.

    The problem with this is that with the house losing value (which it most assuredly is) most people in these oloans will not be able to get out from under them no matter what without simply walking away. If you owe 750k on a mortgage and the house is only worth 650k then not only are you not able to sell it but you are not able to refinance into another loan product without coming up with the difference in cash at the time of the refi.

  8. Mr M, if memory serves me Countrywide offered the libor and mta options for most of their hot products at the time. You are 100% correct that the option (pun intended) chosen was the one that had the lowest start rate and/or paid the most ysp. The borrower did not choose the index because it was not explained to them or at least BOTH were not explained as they should have been in an effort to allow the borrower to choose. Show me 100 TIL’s and I will show you 99 that were incorrect, wrong index #’s, margin, and adjustment/caps. At the very beginning of the Option Arm experiment at least World Savings had it right with the COSI/COFI index. WAMU used the MTA so you could see the 12 month trend. Both had lower ltv’s, manual underwriting, and no 2nd’s were allowed. Portfolio you say, well yes of course because they were protecting their own arses. That changed with time obviously when they could just package them up nicely and sell to unwitting teacher pension funds in Iceland. The Libor index was added at that point to the exotic loans after being so successful in the subprime 2 year arm arena. Ahhh the 2 year arm, the first weapon of mass destruction. Virtually guaranteed future refi business. Remember 2 year arms with a 3 year pre-pay like 8 years ago? You could even raise the margin to get paid more, borrowers looked at start rate only, “How much is my payment” With home price appreciation there were no worries man, we were lovin’ life. Had my very first interview and the manager showed me a hud that paid one of his lo’s $37,500 in fees on a CWIDE Option Arm. 3 points on the back and 2 upfront. God we were greedy and ruthless, but noone was watching that’s for sure. At least it wasn’t fraud, just good ol’ American greed. Creative financing I used to say, long before the organized schemers and scammers came in and ruined it for everyone. I digress.

  9. Mr. Mortgage,
    Do they use overnight, 3 Month or 1 year LIBOR for the reset and do they use an average rate over the time period, or a trailing 30 days or just the spot rate at the end of whatever quarter they are resetting?
    thanks

  10. I worked for Wamu and actually have a 40 year option arm based on the MTA. To my limited knowledge most if not all retail OArms with Wamu where based on the MTA. This is a good thing for my current fully indexed rate is @4.6% and heading south fast. Generally most WAMU margins where between 2.65 to a high of 3.25% with many loan caps at 125%. So maybe Chase doesn’t get killed.

    On the other hand my mentor in the business is a still a huge producer at CW and nearly all of there OA where based on the libor with margins starting at 2.85 and loan caps at 110%. So that means BOA is in huge trouble.

    (BYW while I’m talking about life caps New York State by law required a 110% loan cap on all OArms..that going to get somebody)

    On another matter, all of the 5/1 IO arms that I saw kept the IO payment for years 6 to 10

  11. What would be the mortgage on a Option ARM taken out in June of 07 for $900K that is I believe is a 3/1. Would that adjustment be quarterly or yearly?

  12. I mean what would be the mortgage payments amount for the choices?

  13. In your example with some huge assumptions, the minimum payment in the first 3 years is maybe $3,550. Interest only payment maybe $4,500 using 6% (index + margin), and the full 30 year payment would be $5,400. Again using assumptions, 2.5% minimum pmt rate, 6% fully indexed rate. Could be more or less. 3/1 would indicate a rate fixed for 3 years, so if this option arm had that feature the minimum payment would not go up for 3 years. As far as when it adjusts, you would need to look at the note. Could be monthly, could be annually. Lots of variables missing but that is my best guess.

  14. michaela — Your story sounds identical to the mortgage fraud I saw going on in my neighborhood in Detroit around 2005-2007. Ours is also a historic neighborhood, with huge variations in price per square foot (even larger than your neighborhood I’d wager). The fraudsters would come in and either buy the run-down homes or work with a desperate seller, slap on a new roof, and then sell it at an inflated price to match the comparables on much nicer homes in the neighborhood. This was done with over 20 homes, and they all foreclosed quickly (early payment defaults).

    I never figured out if it was a coordinated effort by a fraud ring, or just a bunch of individuals doing it because it was so easy to do. The deeds all had different names on them for the most part. And there was a wide variety of lenders. Of course almost all of the lenders involved are now on the Imploded list. (Fremont, Long Beach Mtg, Accredited, Washington Mutual, Aurora, Novastar, New Century, etc etc)

    We’ve had one clear-cut fraud case so far in 2008 but for the most part it’s died down for obvious reasons. I’ll be chronicling that one on my blog soon (click on my name).

  15. VacantHomes,
    to find out all the details you’d have to go to the courthouse (Actually, that’s what I did in Atlanta, don’t know your local situation in Detroit) and run the title backwards. I did that on the houses, that I knew about, then I started cross-referencing every purchase by some of those ‘sellers’ and came up with large numbers of purchases/sales by the same people in the same neighborhoods. Then drove by all of those homes and looked at conditions. you can already tell, if they slapped in new vinyl windows – that’s not a restoration, but a ‘slap job’. No real buyer would pay high-end for a historic homes that had the old wood windows replaced with vinyl. They’re not historically accepted. Storm windows would be. I figured out what real values would be (having been a real estate investor that farmed that neighborhood I knew what was gong on there) and turned all my research over to some other people.

    The mortgage companies you mentioned were certainly right in the middle of all of that.

  16. Thanks MM. You should have your own TV show or column in some periodical. But most MSM would not like the news you’d be putting out. Truth hurts those guys. But your analysis is very good.
    This is just gasoline on the fire. And why not, it’s getting cheaper for a gallon of the stuff anyway.

  17. I got an option arm in Aug.’05 It hasn’t reset yet but I stopped making pmts. in May of ’08 after trying to sell it (short sale) for almost a yr.
    American Home is BK so I can’t get a loan mod. etc.
    I stopped caring in March, talked w/ an attorney…and am in the foreclosure process.
    I have Heloc on top of the neg-am. I called the last year daily and never got a return call…now they’re calling me.
    I will file bk when I get a N.O.T. in Dec.-Jan. get more time to save $$$ to rent a place.
    I figure if Wall St. gets their bailout I really could care less about my house…let the “lender” whomever that is have it back.
    This is happening all over here in beach area of OC….SO MANY people got into their house w/ a Neg-AM….
    Congress/Paulson/Bernanke/Bush really don’t comprehend the financial devastation that will occur when people walk en masse on these TIME BOMBS and it will be before the resets…
    Most beach homes are in the 800k-1.5mil.

  18. Chad, in my relative’s example, after 10 years (IO) would it definitely turn into a 20 year ARM? Or is there a chance they could lock in a fixed rate then? Thanks.

  19. American’s don’t care about homes, but wealth.

    To all of those who talk about American homeownership being a right or some entitlement or something like that…to anyone who ‘feels the pain’ of homeowners being foreclosed upon, or is one of them, I have a message for you:

    Americans don’t care about being homeowners. They don’t. They couldn’t care less if they actually owned the house, the land, or anything else for that matter.

    Americans want to be, strive to be and care about being wealthy. Nothing inherently wrong with this. They will do, buy, or act in just about any fashion to cause this to happen. If they could be financially dependent, wealthy, etc. from buying and selling tulips, they would do this.

    Americans look at homes, and treat them, as an investment. Period. Any investment has risk. Investors should know about risk and uncertainty. They should also know that sometimes they lose. And be prepared for it.

    As for the rest of the world pointing at this mess starting in, and being caused by the US; poor lending, poor oversight, corruption, collusion, ratings agencies not doing their job the list goes on, I say to the rest of the world, “Take responsibility for your actions, too.”

    When they were buying MBS reportedly rated as AAA they didn’t see those securities were based on US homes, mostly in CA that were increasing in value at astronomical rates by historical standards?

    Come on. Take some responsibility.

    JAllen

  20. Here is the TED Spread from Bloomberg. The TED spread hit a record 4.13 this morning. This is far above the highs reached during the previous waves of the credit crisis.

  21. […] (Level 2) Banking System on MERRILL LEVEL 3 ASSETS SURGE NEARLY 70% TO $82.4 BILLION IN Q1Stu on LIBOR Spike Not Only Hurts Suprime…Pay Options, Jumbo Prime, Alt-A TooJosh Dowlut on Wachovia’s New Pay Option ARM Plan – ‘The Spend’Thomas Dae on […]

  22. michaela — Thanks. Actually, I more or less did what you suggest, I started looking up some of the seller names in the county deed system (fortunately there is a website for them at http://www.waynecountylandrecords.com ). I did find a couple of sellers whose name appeared on several other homes in the county which had then quickly foreclosed. I gave those names and the foreclosure information to the authorities. But for the most part, all of the names involved were different, which makes me think that the real problem was that fraud was so easy to perpretrate in 2005-2007, that a lot of people were doing it… it was a regular cottage industry.

  23. Mr. M,

    At dinner in Dec 2006 with a VP of Chevy Chase, he said all MTA’s had a back-end formula directly tied to LIBOR, since everything in the banking world revolved around LIBOR. MTA was lower at the time so it was being promoted.

    Looks like another destructive hidden derivative that average people had no idea they were exposed to.

    When does the entire banking system go into receivership to reorganize and restore the faith?

    AV

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