Newsletter – March / April 2010 – The Second Wave

The Second Wave

I hope the rumours are not true. I hope there are no such things as re-sets and Option ARM and ALT-A mortgages in the USA. The sub primes were bad enough.

Remember what happened in the sub prime fiasco? A trillion dollars US was loaned to homeowners who couldn’t afford their mortgages on homes that were barely worth the amount of the mortgage loan. When the people couldn’t make their payments, the value of certain mortgage-backed US investments went to ZERO. And the banks all over the world who owned those now worthless investments were taken to the edge of solvency: many had to be bailed out by their various governments. And now we are all breathing a collective sigh of gratitude: the bail outs worked. The wave of sub prime re-sets and defaults has crested. The banking system of the world survived.

What’s a “name your payments” mortgage? You guessed it! When the new home buyer moved in, their monthly payments were so low they produced negative amortization. Because the “name your payments” payments didn’t even cover the interest, the mortgage actually got bigger over the first few years! Instead of paying it off in 30 years, now it would take 35 years! Mortgage loans were offered with “too low” monthly payments for 1, 3, 5 or 7 years. Once that period is over, the mortgage loan repayments are re-set so the loan actually does start to get smaller. Some home owners face doubling or tripling their monthly mortgage payments when the re-sets come.

Other Option ARM or ALT-A mortgages were underwritten at artificially low interest rates, same as the sub primes. The re-sets will bring these interest rates back up to normal, increasing monthly payments and increasing the risk of defaults.