Roughly half of all performing first mortgages will experience a monthly payment increases over the next five years, according to a new report from Fitch Ratings.
The mortgages in question back private-label residential mortgage-backed securities (RMBS), meaning they aren’t guaranteed by Fannie Mae, Freddie Mac, or the FHA/VA.
As a result, many of these loans haven’t qualified for interest rate relief via programs such as HARP.
Unsurprisingly, mortgage payment increases have historically led to higher default rates, which could spell trouble for the housing recovery that seems to have slowed in recent months.
The larger the payment increase, the higher the chance the borrower will fall behind. Fitch estimates that loans with the biggest increase in payment are about three times more likely to default than loans with no payment increase.
Fitch Ratings director Sean Nelson pointed out that borrowers with interest-only loans are expected to see the largest monthly payment increases.
Monthly Payments Could More Than Double
As I’ve said before, these borrowers get hit twice; aside from having to make the fully-amortized payment, they also have a shorter repayment period to pay off the mortgage after deferring principal payments for the first 10 years of the loan.
Nelson said many homeowners could see their payments more than double as a wave of 10-year interest-only recasts hits.
Many of these loans were taken out in 2004-2006 at a time when home prices also happened to be peaking. That means we could see a new wave of defaults, especially if home prices slip from current levels.
Despite the gains, there are still millions of underwater homeowners, so it could be the final nail in the coffin for some.
But it’s not just IO loans that are a problem – modified loans and adjustable-rate mortgages are also at risk, though Fitch said the magnitude of payment increases should be smaller.
Those who took part in the Home Affordable Modification Program (HAMP) will see payment resets from 2014 until 2021, with incremental 1% increases annually until rates reach the national average for a conforming 30-year fixed-rate mortgage on the date of the original modification.
ARMs will rise as short-term interest rates increase, though with the LIBOR still super low, many borrowers might be better off letting their loans reset to current fully-indexed rates.
The good news is that prime jumbo loans are the most exposed to future payment increases thanks to their large composition of ARM and IO loans. About two-thirds are “at risk,” per Fitch.
Meanwhile, less than half of subprime mortgages are expected to see payment increases, which is good because these homeowners tend not to have many alternative financing options.
The prime bunch should be able to refinance fairly freely, assuming they’ve got the required equity from recent home price gains.
And this whole wave of resets could actually save the flagging refinance market, which has been pretty lackluster after a few really strong years.
Most borrowers already took advantage of the low interest rates on offer, but those facing a payment reset might look to lock-in a long-term fixed rate.