Mortgage Default Worries Rise as Adjustable Loans Reset

February 27, 2007 No Comments »

Many investors are anticipating widespread defaults as adjustable-rate mortgages reset to higher interest rates this year.

An estimated $600 billion in adjustable rate mortgages, of which two-thirds are subprime, are due to rise as the fixed-rate periods end later this year.

The majority of adjustable-rate mortgages are hybrid loans, meaning they’re fixed mortgages for the first 3 to 5 years, and then become adjustable for the remaining 25 years.

These 30-year loans go by the name 3/27 or 5/25 ARM, and once the fixed period ends, the rate can become a monthly or annual adjustable, a dangerous loan for many homeowners who are already struggling to make their mortgage payment.

While this was a concern in the past, the sharp rise in mortgage rates over the past few years means many homeowners will face payment shock when their loan resets, with many adjustable-rate mortgages climbing as much as 2-3%, a difference of hundreds to thousands of dollars per month.

This is why many bond traders and analysts believe mortgage defaults will rise significantly, especially in the subprime sector, where loans were basically handed out to anyone with a credit score.

The price of insuring against default on subprime mortgage bonds rated BBB- rose to a record high of 15 percent last week, up from 2.5 percent no more than a month ago.

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