The Regional Problem with Fannie Mae’s New Program
Overview of the Homestay Program
Fannie Mae, the original creator of the industry now known as subprime, is introducing a new program called Homestay to help borrowers who are in adjustables mortgages recover safely from payment shock. The program has a three phased approach that will allow lenders to work with homeowners about to experience a spike in their monthly payments to switch to a fixed rate loan. Despite all the attention, in my opinion this new program will not have much of an impact in the imploding California subprime market.
Background of the Adjustable and Pay Option Arm
During the low rate period of 2001 - 2004, many borrowers locked in ARMS that were fixed at that rate for 3, 5, 7 and 10 years. Though great for getting in homes and keeping rates low, these ARMS are fixed at rates that no longer exist. Part of the problem is that these ARMS are about to come due. A borrower who had a fixed 4.2% interest only ARM is about to have it reset to modern rates at about 6, 7 or in some case 8%.
Also during this time, reverse amortization mortgages became popular. Reverse amortization loans let a borrower pay a minimum payment (commonly called a teaser rate) which is a bare fraction of the total interest . These loans are ones that let the borrower make a small portion of their interest payment while deferring the rest onto the balance of their loan every month. Although the small payment is fixed for a year, every year on the anniversary of when the loan originated, the payment jumps by 7.5% of the balance. In other words, assuming a $100 payment, the following year the payment would jump to $107.50 and the next year it would jump to $115.56. This will go on for 5 years. On the fifth year, the minimum payment on most loans doubles or triples as the loan starts to pay itself off. Since the loan is now larger than when it was first financed, the payments are considerably more than they were when the borrower got into the loan.
Why the Homestay program has a huge problem in California
In the real estate boom, California was one of the biggest growth areas. Real estate values nearly tripled in just a few short years and though equity climbed to an all time high, the convenience of the programs described enabled none of the debt to be paid off. With rising home values, homeowners started to take out massive amounts of home equity or made some huge profits on the sale of their property only to buy more property that was more expensive and had more debt.
From a macroeconomic perspective, the debt load still exists. None of the debt that has been used to finance real estate has been paid off. The debt has merely just shifted owners.
Consider this…
The Homestay program will allow owners with imploding adjustables to refinance into fixed rates or more stable programs, but with such a large debt load, who will really be able to afford their home? For example, if people from 2002 that have option arms and adjustables resetting this year are given an option to refinance their $500K mortgage at 4.5% interest only to a $500K mortgage at 6.0% fixed, that’s a jump of $1100 in monthly payments. Not to mention, the additional cost of rolling in seconds or HELOCs that these individuals may have on the property.
Worse yet…what about the individuals that are paying only 1% on their homes? For an original $300K home, a 1% loan adjusting since 2002, has a current minimum payment of $1285/month. Sometime this year that payment will jump to two or three times its size as the pay option arm begins to pay itself off regulary. Even at a 6.5% fixed mortgage, the new payment is $2085 (with $330K as the new balance since the original loan will have no doubt drastically ballooned in size).
In my opinion, Fannie Mae’s program is great but will not have much of an impact in California. The high debt load here along with the abundance of individuals that bought homes that they realistically could not afford is going to continue creating a down market.