Tuesday, March 25, 2008

Falling Rates Help Borrowers, But For How Long?

(Housing Wire) A report released Tuesday by Standard & Poor’s reinforces earlier coverage here on Housing Wire — that falling 1-month and 3-month LIBOR rates have largely removed payment shock as an imminent threat for most hybrid ARM borrowers. The Fed’s aggressive policy of cutting its target funds rate has pushed key LIBOR rates below 3 percent, largely rendering payment shock irrelevant for many borrowers.

Unfortunately, however, the idea that ARM borrowers are out of the woods is true only so far as it goes: and that isn’t very far.

For subprime borrowers, S&P found that LIBOR rates ranging from 2 percent to 5 percent are the danger zone; rates below 2 percent render payment shock insignificant for most subprime borrowers, while rates above 5 percent would put subprime hybrid ARMs at the rate cap and render higher rates ineffectual from a borrower’s standpoint. At the current level, most subprime borrowers are only seeing a “shock” hovering around 1 percent, relative to their teaser rate — a number that goes up drastically as LIBOR increases.

For Alt-A borrowers, S&P suggests that the recent drop in LIBOR has “virtually eliminated” payment shock — but any increases of LIBOR above 3 percent would rapidly increase payment shock for Alt-A borrowers up and through a 6 percent ceiling. (Alt-A borrowers, however, are defaulting in droves regardless of payment resets, as we reported late last week).

To put this issue into perspective, consider that there are $4.3 trillion in hybrid ARMs resetting during 2008. Let that sink in.

That’s $4.3 trillion worth of borrowers that are now, essentially, hostage to LIBOR rates that they absolutely need to stay low in order for them to stay in their homes. With property values plummeting in areas where most hybrid ARMs are concentrated, home owners are finding their combined loan-to-value in most cases is outside the new, revised guidelines that most lenders now require.

Freeze of limited help, at best
Extending an ASF mortgage rate freeze plan originally developed for subprime borrowers into the troubled Alt-A market — the most likely option on the table should LIBOR increase — is likely to have only a modest effect, according to separate report published Tuesday by Standard and Poor’s. Especially for option ARM borrowers, many of whom now find themselves owing much more than their home is worth.

“We believe that only a small number of Alt-A borrowers will be able to refinance through a loan modification based on the ASF framework’s guidelines,” said credit analyst Mark Goldenberg, a director in Standard & Poor’s residential mortgage ratings group.

“Due to a combination of tighter underwriting and declining property values, many short-reset ARM borrowers, especially those with little home equity, may default as loans reset because refinancing into a new loan may not be a viable alternative for them.”

“Based on the performance of option ARM loans, we feel that servicers will likely need to take preemptive action to avoid losses,” he said.

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