Economist's Commentary: May 8, 2008
Subprime ARM Resets to Reach Peak in 2008
By George Ratiu, Research Economist
With legislators in Washington still focused on stemming foreclosures, the continuing credit crunch continues to take its toll, as evidenced by Fannie Mae's announcement this week of a $2.2 billion loss for the first quarter of 2008. However, the Fed's recent quarter percent rate cut provided both a signal that it will likely keep its funds target on hold and some relief for resetting adjustable rate mortgages (ARMs).
The rate cuts are likely to offer relief, in particular, to subprime ARM holders. Looking at the past five years, subprime ARMs increased in popularity starting in 2003 and peaking in 2006. In fact, during 2006, 91 percent of all subprime loans issued were ARMs. Of these, 61 percent were 2-year and 3-year hybrid loans.
During the same five-year span, the one-year ARM interest rate moved from 3.9 percent in the first quarter of 2003 to 5.6 percent in the last quarter of 2007. The interest rate also hit its five-year peaks of 5.7 percent in the second and third quarters of 2006, as well as the third quarter of 2007.
The prevalence of subprime ARMs (especially 2/28) combined with increasing interest rates partially explains the jump in these loans' foreclosure rates. During 2003-07, foreclosure rates for subprime ARMs increased from 7.3 percent to 13.4 percent. In contrast, foreclosure rates for all loans hovered in the range of 1.4 percent to 2.0 percent.
Considering the broader perspective, subprime ARMs constitute only 6.1 percent of all outstanding mortgages (and only 4 percent of all homeowners). However, the loans account for 40.5 percent of foreclosures.
In light of these factors, 2008 is likely to be a peak year for subprime ARM resets. Based on data released by the Federal Reserve Bank of New York, the volume of upcoming resets will reach $55.5 billion in the first half of 2008, $80 billion in the second half of 2008 and $72 billion in 2009.
Looking ahead, it is obvious that subprime ARMs will continue to contribute to the number of foreclosures. However, the Fed rate cuts have already had an impact on the reset shock. Moreover, subprime ARMs are tied to the 3-month LIBOR, which has been lowered by the Federal Reserve cuts. In fact, from July 2007 to April 2008, the LIBOR has fallen from 5.4 percent to 3 percent.
For REALTOR® members, more information on subprime ARM performance by state is available here.
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