Alt-A Mortgage Disaster in 2010-2011
In a phenomenon that couldn’t be more ill-timed, tens of billions in Alternative mortgages are due to be reset in 2010-2011. Though not sub-prime, many of these loans are interest-only, those in which the borrower makes no payments on principle. Once reset, borrowers could have monthly payments 15-20% higher than today.
The Gamechanger
Just a few years ago, when real estate was liquid and homes were selling for more than the asking price, interest-only loans burst on the scene in what clearly demonstrated the market was in a bubble. Interest-only loans are just that, monthly payments purely on interest with the borrower owning 0% of the home whether he or she had been paying on the debt for 6 months or 60 years. These loans were popular with speculators and over-leveraged average borrowers alike, and allowed buyers to buy more than they could truly afford to.
Also, interest only loans were loved by the banking industry due to their frequently high closing costs/fees which generated huge front-end profits. A banker could make the loan, seal a 2-3% profit at closing, then go on to sell the loan to Fannie Mae/Freddie Mac and generate even more quick cash with no risk. Needless to say, the banking industry loved touting these loans to buyers.
How Interest Only Loans Worked
Most interest only loans weren’t to remain interest-only forever. Many were brokered so that the payments would be interest only for 3-5 years before reset to new interest rates as well as new payment terms. Often, at the end of the first term, the mortgage would reset to a conventional 30-year loan that would include some payment on principle. When the shift occurs 5 years after the loan was made, the payments would increase as much as 15-20% due to the fact the borrower was now paying interest plus adding a significant portion towards the principle of the loan.
The Deal with Alt-A Loans
As we already know, mortgage delinquencies are up over 250% from 12 months ago due mostly to domestic job losses and a weakened economy. When these loans are reset, monthly payments are sure to rise, creating more delinquencies and ultimately more foreclosures which many predict will further restrain the climb in housing prices.
