More news that the real estate market is in for a soft landing comes from First American Real Estate Solutions in a study that says the impact of riskier home loans will barely send a ripple through the economy.
There are, however, important clues in the study that should make home owners take stock of the level of risk in their current home loans.
Analyzing the impact of adjustable rate mortgages (ARMs) converting from low, teaser interest rates to higher prevailing mortgage market rates, "Mortgage Payment Reset: The Rumor and the Reality" found that defaults related to the loans will represent $110 billion in losses, a fraction of total mortgage lending, and a drop in the bucket in terms of a drain on the overall economy.
The chunks of sky that do fall will land on the households of home owners most vulnerable -- equity poor, home owners with that include interest-only and negative amortization features.
The study found little risk difference among owner-occupied home owners vs. investment property owners, but that wasn't true when comparing fixed-rate mortgages (FRMs) with ARMs.
"Seventeen percent of properties with ARMs have negative equity, while only 7.2 percent of properties with fixed-rate mortgages are in this situation. These numbers show that many adjustable-rate mortgage borrowers have low equity in their homes, often having bought recently and stretched their financial abilities to acquire a home with a low down payment and a low monthly payment," the report found.
First American used data from LoanPerformance a research firm it acquired last year and found most at risk, should mortgage payments adjust, home owners with ARMs with low initial "teaser" rates of 2 percent on homes with less than 15 percent equity. Those loans represented about $70 billion in potential losses out of the $1.8 trillion in ARMs issued in the last two years.
For example, borrowers paying 1 percent on a $300,000 mortgage -- about $965 a month -- would see their payments double to $1,799 if their loan adjusted to a 6 percent rate.
Of the home loans with initial interest rates of 1.5 percent to 1.9 percent, 19.1 percent of home owners had negative equity. This percentage was higher for other groups of home loans with initial loan interest rates below 3 percent. Many such loans are interest-only others are option-payment loans requiring only a minimum monthly amount even lower than that of a 1 percent interest-only loan.
The study said many of these home owners have stretched their finances to purchase or refinance a home, making only small down payments as purchasers or borrowing most or all of their home value as refinancers.
More traditional ARMs with initial interest rats of 3 percent to 5.5 percent carry near market-level interest rates equal to or near to those of prevailing fixed-rate mortgages and will continue to adjust with only moderate risk.
ARMs at or higher than market levels from 5.5 percent to 9.9 percent carry more risk for the borrower and the lender, the report said, because borrowers have stretched their finances, often supplying low down payments and paying high interest rates. The proportion of these properties with negative equity can exceed 30 percent.
However, negative-equity percentages actually decline on loans with higher interest rates, likely because of tighter loan-to-value underwriting rules. Also the initial payments are already high and subsequent adjustments will be smaller with less impact, the study said.
ARMs acquired in the last two years were also considered "a problem set of mortgages" because there's been less time for equity to grow.
First American's database covers more than 2,500 counties representing 97 percent of the nation's real estate transactions.
States with housing markets frequently considered most at risk because of high home prices that force wider use of riskier loans -- New York, Hawaii, Massachusetts, Connecticut and New Jersey -- will actually face less risk because those high home prices come with equity stakes that will help see home owners through hard times.
Other states with a high percentages of risky loans but fewer borrowers with equity -- Tennessee, Colorado, Minnesota, Alabama and Arkansas -- are more at risk for greater economic impact due to rates ratcheting up, the study says.
"Mortgage payment reset is likely to be the most important issue facing mortgage servicers and investors in the non-prime market during the next few years," said George Livermore, president of The First American Corporation's Property Information and Services Group.
"This analysis provides helpful guidance for mortgage professionals by explaining key dynamics associated with mortgage payment reset and provides a method for evaluating risk."
While the study is designed to help lenders get a grip on their risk, it's also a tool for consumers to take stock of their risk.
A new loan today -- even at a higher, but fixed and locked-in rate -- could prevent a still higher and more unaffordable mortgage in the future as mortgage rates continue to rise.
