Low Equity, Low ARM Rate Could Lead to Florida Home Loan Trouble

Speak with some Florida home loan experts and you’ll hear that adjustable rate mortgage increases/losses will be spread out over the next few years. The result? No real danger to the housing market.

Other insiders, however, believe that foreclosures will rise significantly over the next few years, as a result of increased interest rates on these home loans. While each foreclosure is traumatic for the family that loses a house, it’s generally agreed upon that the coming wave of defaults won’t swamp the system.

Which Florida home loan owners are in the most danger?

The borrowers who are in the most danger have two strikes against them. First, they are (or will be) owing more than the house is worth. Secondly, they have adjustable-rate mortgages, or ARMs, with low “teaser rates.” Eventually, after anywhere from one month to five years, the ARM enters its rate-adjustment period and the Florida home loan is reset with a higher rate.

Quite a few homeowners have these two strikes against them, and almost $200 billion in foreclosures will result, says Christopher Cagan, director of research and analytics for First American Real Estate Solutions.

Cagan prepared a report in February that measured the extent of the risk to the mortgage market. It’s not a financial-planning guide, but here’s what consumers can take away from it:

• If you have an ARM with a teaser rate of 2.5 percent or less, watch out, because the monthly payments could skyrocket - even double - after the rate is reset. Additionally, if you owe more than the house is worth, you could find yourself in serious trouble - unable to refinance and unable to sell without a loss.

Reasons for defaulting on a Florida home loan

Larry Goldstone, president of Thornburg Mortgage, says, “Generally speaking, I think people are good people. They borrow money with the intention of paying it back.”

This doesn’t mean they always can. When the business cycle moves down and people lose their jobs, more of them default, Goldstone says; it doesn’t matter much if the borrower gets a 30-year, fixed-rate mortgage or a non-traditional Florida home loan, such as a payment-option ARM, in which the minimum payment doesn’t even cover that month’s interest.

David Greco, vice president of credit policy for MGIC, agrees that the loan type doesn’t matter much. A precarious mortgage, he says, is one “where the likelihood that they’ll be able to repay it is low, and I don’t think there is anything that is inherently risky about any loan programs that are out there today.”

Assessing Florida home loan risk

The risk comes from the possibility that the borrower and lender didn’t accurately assess the borrower’s ability to repay, Greco says. One person might be able to handle a payment-option ARM with aplomb, while another person might wilt under a 30-year fixed loan.

That’s not exactly how the federal government sees it. Regulators have proposed guidance urging lenders to be more careful with interest-only home loans and payment-option ARMs, especially in cases where the homeowner has little or no equity in the house or when the borrower produced little or no documentation of income and assets.

Bankers worry that the guidance could result in fewer Florida home loans to deserving home buyers.

“The question is, without these products, would we be better off? The answer is no,” says David Herpers, chief marketing officer for Amerisave, a lender that specializes in customers with damaged credit. “I think, as a consumer, these emerging mortgage products are, overall, extremely beneficial.”

Anthony LaGiglia, a financial planner with J.J. Burns & Co. isn’t as sanguine about nontraditional mortgages.

“When you look at interest-only mortgages, they were for a very select group of people - a business owner or a Wall Street person who gets a huge bonus every year,” he says. “But they’re becoming more commonplace. A lot of people are using [exotic Florida home loans] just to afford a house. A lot of people are getting in over their heads.”

This brings us back to Cagan: what will happen when borrowers’ payments spike after ARMs hit their adjustment periods. He says there will be an extraordinarily high default rate among people who got teaser-rate option ARMs and who have less than 15 percent home equity. But those people are a small part of the overall pool of homeowners.

“Nationally, I think it will be a common cold, if you will,” Cagan says, while acknowledging that it will feel much worse to the people who lose their homes to foreclosure.