Will Option ARM Resets Negatively Effect the Housing Market?

Are we in for a national crisis with option ARMs  resetting in the next several years, or it is all just a bunch of baloney?

Option ARMs were the most popular types of mortgage product between 2003 and 2006, as they provided many borrowers who otherwise would be unable to afford a home with a chance to purchase. Offering low “teaser” mortgage rates for a fixed time (usually 5 years), interest rates were scheduled to readjust some time in the future. 

Many of these loans were pay option ARMs, giving borrowers the ability to choose how much they wanted to pay each month. If the borrower elected a lesser-than-full amount the payments did not go toward the principal balance of the loan.

Many borrowers jumped into these loans with the idea that they would be able to sell their homes for a profit or, in the alternative, refinance before the rates reset. When the housing market turned around these borrowers were stuck in homes for which they had not paid down any or much of the principal, and over the last several years many of those homes have lost value.

The result is the majority of borrowers facing rate resets are underwater with their mortgages, owing more than their homes are worth—on average 126% more.

It is predicted that from 2010 to 2012 there will be approximately $150 billion of option ARMs resetting.  Some predict this will lead to a slew of new foreclosures across the country.

The opposing view is that the resets will not have a catastrophic effect. One reason is that the Federal Reserve has kept short-term rates at record lows. As long as this continues borrowers may actually benefit from rate resets, providing them with lower payments.

Some say that the rates have remained historically low because of the infusion of cash from the government, and that once this bail out ends the rates will go up.

Although this may be a valid point it is doubtful that markets across the nation will be inundated with foreclosures. The higher-cost areas may be hit harder, as there is a prevalence of these loans in those areas (for example, in Northern California).

Another point to keep in mind is that the government is currently working to help the housing market and the economy as a whole. As the housing market is a huge indicator of the stability of the economy it would be detrimental to ignore this problem, raise rates and allow a new foreclosure crisis to begin. New programs may arise before the resetting begins.

It remains to be seen what will come of the rate resets from option ARMs, but one thing is clear: Washington needs to come up with some new programs to help those in this situation.