2006: An ‘Adjustable’ Year for Foreclosures

The Federal Home Loan Mortgage Corporation (better known as Freddie Mac) has just released the results of its 23rd Annual Adjustable-Rate Mortgage survey of prime loans. Based on data collected between December 18 and December 21, 2006, the survey cited three major conclusions:

• That the overall market share of adjustable-rate mortgages (ARMs) as a whole declined in 2006 as the savings gap in interest rates between ARMs and fixed-rate mortgages shrank;
• Lenders offered greater incentives (discounts) in 2006 in order to maintain the flow of ARM originations coming in the door; and
• Hybrid loans — particularly the very popular 5/1 ARM where the teaser interest rate is fixed for five years before the lender can push the interest rate upward — became the most popular type of ARM in 2006.

In fact, the survey found that 5/1 hybrids accounted for 40 percent of all loan originations last year. That is a stark contrast to 1999 when two out of every five ARMs were traditional one-year adjustables. The initial interest rate on the 5/1 hybrid ARM in 2006 was 5.96 percent (0.5 percent above the rate on the traditional one-year ARM, and 0.2 percent below a 30-year fixed-rate mortgage).

Five out of every six lenders who offered ARM products had a 5/1 hybrid ARM available, while only 52 percent of all lenders offering ARMs had a one-year traditional ARM product available.

As Frank Nothaft, Freddie Mac VP and chief economist explains it, “A 5/1 hybrid ARM provides the consumer the comfort of knowing that the interest rate will be fixed over the first five years of the loan. However, the interest rate may jump as much as five percentage points on the fifth anniversary.”

And that is why RealtyTrac has been warning that many home buyers maybe find themselves in financial distress this year or next. It is the potential for problems created by these hybrid or “option” loans (as they are known), that economists and financial experts have been concerned about. Home buyers who utilized these loans to finance a home purchase in either 2005 or 2006 are probably at the greatest risk of going into foreclosure if they cannot afford a mortgage payment that could be 25-50 percent higher when the interest rate adjusts upwards.

RealtyTrac tallied nearly 1.3 million properties entering foreclosure nationwide during 2006 — a large increase from 2005 when approximately 850,000 properties went into foreclosure. Based on the continued popularity of these hybrid loans over the past few years, there is no reason to conclude that the level of foreclosure activity around the country should dissipate anytime soon.

The 5/1 hybrid ARM has been very popular, particularly with families planning on having the mortgage for five years or less before refinancing. But for those families whose household income has not kept pace with the rising costs of living, there may be some tough years ahead — in the short term at least. And these are some of the homeowners that subscribers to RealtyTrac will be set to help out of a financial crisis once they have been identified.