Just as the sub-prime rate resets rattled the economy in 2007 and 2008, a new groundswell of adjustable and Alt-A mortgages could send the US real estate economy for a second twist.
Weighing the Problem
While investors focus on the commercial real estate bubble that is still unwinding throughout the United States, a silent storm of resets in the residential markets could send home prices back into a second freefall. More than $350 billion in residential loans are due for a rate reset as option adjustable rate mortgages. Trailing close behind that figure at nearly $250 billion are Alt-A mortgages, a type of exotic mortgages that were the main product during the real estate boom of the early 2000s.
Although less risky than their sub-prime counterparts previously removed from the system, Alt-A mortgages are still riskier than traditional A paper. Alt-A mortgage holders typically have high debt-to-income ratios, poor credit history (though better than sub-prime borrowers), and poor loan to value ratios. Therefore, those with Alt-A mortgages are either biting off more debt than they can chew, have a poor history of making good on their debts, or live in a home in which they've borrowed a greater percentage of its market value and are likely “upside down” on their holdings.
As these loans will be up for rate resets in 2011, the Federal Reserve will play a key role in how many Alt-A borrowers go underwater. Should the Fed raise rates aggressively, Alt-A borrowers will inherit an incredibly high monthly payment. However, if the Fed keeps rates extremely low as they have for the better part of two years, borrowers will pay roughly the same amount each month in interest and principal and suffer few consequences.
2011 Will Make or Break the Market
The eventual outcome from 2011 resets is either the same market we've seen for a number of years or a significantly worse housing market. To put it simply, there is no room for growth – only the possibility that a whole slew of homeowners will again face foreclosure, and the real estate market will have to absorb thousands of homes on the market. If the Fed gets aggressive come 4Q 2010, look out: the real estate market will face another plunge.