The Next Real Estate Crisis will be worse than ever before

[mobes]

The Next Real Estate Crisis
By April, 2009, hundreds of thousands of option ARM mortgages will begin resetting, bringing on a fresh wave of foreclosures

The American homeowner must feel like one of those characters in an old cartoon who has just been hit by a falling piano. After dusting himself off and touching the large bump on his head, he probably doesn't expect another piano to be dangling overhead. But he'd be wrong.

But what's often funny in a cartoon is anything but in real life. With the subprime mortgage crisis already crippling the U.S. economy, some experts are warning that the next wave of foreclosures will begin accelerating in April, 2009. What that means is that hundreds of thousands of borrowers who took out so-called option adjustable-rate mortgages (ARMs) will begin to see their monthly payments skyrocket as they reset. About a million borrowers have option ARMs, but only a fraction have already fallen due.

That was the catch to option ARMs; borrowers were offered low initial payments that would recast higher after several years. Many home buyers thought they could resell their homes before their payments increased. But instead, many of them got trapped. According to Credit Suisse (CS), monthly option recasts are expected to accelerate starting in April, 2009, from $5 billion to a peak of about $10 billion in January, 2010. Some of these loans have already started to recast. About 13% of option ARMs that were issued in 2006 were delinquent by 60 days by the time they were 18 months old, Credit Suisse said.

California: Problem's Bellwether

Among the states expected to be worst-hit is already battered California. Today, outstanding option ARM loans in the U.S. total about $500 billion, about 60% of which were sold to California homeowners, according to Credit Suisse. Option ARMs were especially popular in the state, where they were heavily marketed during the boom by such companies as Countrywide Financial (CFC) in Calabasas, Calif.; Washington Mutual (WM) in Seattle; and Wachovia (WB) in Charlotte, N.C. Moreover, on top of their ARMs, many homeowners also refinanced their homes, driving themselves even deeper into a debt they thought they could escape by flipping their homes.

But California won't be alone. Homeowners are also frighteningly vulnerable in states such as Arizona, Florida, New Jersey, and others.

The Mortgage Bankers Assn. said on June 5 that the option ARM problem is growing. The group reported that the national rate of foreclosure starts for prime ARMs, including option ARMs, increased to 1.55% in the first quarter, up from 0.53% a year earlier. In California the foreclosure start rate in the first quarter was 2%, vs. 0.5% a year earlier. In Florida, the rate was 2.57%, compared with 0.5% in the first quarter of 2007. "California, Florida, Arizona and Nevada combined