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We hope that many of our readers saw the New York Times article “Mortgage Holders Find It Hard to Walk Away From Their Homes,” which ran on May 10, four days after our “What Stage of the Sub-Prime Crisis are We In?” The Times story claims there is “little evidence that people who have the means to pay are walking away from their homes as values sink.” Oddly, their article focuses on homeowners with FHLMC and FNMA mortgages, and not on sub-prime borrowers. The Times claimed the data was too hard to find for the sub-prime market. In fact, the data showing sub-prime borrowers are walking away from their homes is readily available, and is presented in our previous article as well as below.
Had the Times looked into the sub-prime market, they would have written an entirely different story.
In fact, they might have written our story.
We also received this letter from one of our readers:
Keep in mind that mortgages reset at an index plus a spread. Interest rates are down 325 basis points from about 6 months ago. So, many resets will be lower or about the same as the teaser rate. Plus, people need a place to live and even if they have negative equity they may not walk away from the home if they can afford the payment. Demographics work in real estate's favor as over time new households are formed. Plus, the MBS (mortgage backed securities) market has priced into it probably greater than current defaults. Look on the bright side.
First American CoreLogic, who provides mortgage data through its LoanPerformance service, gave us the following data, which shows the initial “teaser” rate on sub-prime loans:
Year of Origination |
“Teaser” Rate |
2007 |
8.47% |
2006 |
8.48% |
2005 |
7.49% |
2004 |
7.17% |
2003 |
7.47% |
2002 |
8.48% |
2001 |
9.53% |
2000 |
10.64% |
Average |
7.93% |
The term “teaser” is really a misnomer, because these rates are not particularly low. Mark Fleming, Chief Economist with First American CoreLogic, indicated the average spread for sub-prime loans that have not yet reset is currently 5.94%. Approximately 97% of sub-prime loans are indexed to the 6-month LIBOR rate, which today (May 9, 2008) stands at 2.88%. Thus, if the remaining sub-prime loans were to reset today, they would carry an interest rate of 8.82%, 89 basis points above the average initial teaser rate.
However, very few sub-prime borrowers ever intended to carry their loans to term. According to a December 2007 Federal Reserve paper, 71 percent of 2004 sub-prime 2/28 ARMS nationally were retired in two years, and 88 percent in three years. (A 2/28 ARM carries a fixed rate for two years and a variable rate for the remaining 28 years.) This same paper states what is commonly known, that “rising house prices and the abundant availability of financing were key factors allowing the re-financings.”
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