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My Home About Me Profiting With Forex Lower Rates Won't Cure Housing And Mortgage Ills Posted on 10/08/2007 06:59:43 | Link | Post Comment In case you missed it, one of our readers submitted a news item from Forbes.com providing a long-term look at interest rates and housing. Read the Forbes.com article here. In the article, Bill Gross (fund manager at Pimco) offers thoughts around the mortgage and housing crises, and quickly surmises that these two issues will dominate Fed actions for "years to come." If he's right, and if you're prone to motion-sickness, you might want get off this housing/mortgage/interest rate roller-coaster ride, 'cuz it 'aint endin' soon. So the article got me thinking about why I wasn't made all warm and fuzzy by the recent Fed action of lowering interest rates. What affect might it have on housing and mortgages in the short-term? Can the USD survive another 2 years of bad news? Does Bernanke put his pants on one-leg-at-a-time? The conclusion I came to is that, not only are we not out of the woods, we haven't even seen the forest yet. Those of you who think we're seeing light at the end of the housing/credit tunnel ought to take stock of a major issue not yet fully played out: Adjustable Rate Mortgage (ARMs). (Continued below) Last May, Fed Chairman Ben Bernanke said that 30 percent to 40 percent of all mortgage originations in 2005 fell in this "nontraditional' category. He went on to say he enjoys egg-salad sandwiches and listening to Vivaldi before bed, and on that news the Dow dropped 745 points. Just kidding, but here's why his comments about ARMs are important to us today: Most ARMs adjust after 1, 3, or 5 years. That means it's likely that less than half of the 2005 ARM loans adjusted in 2006 or thus far in 2007. That means as much as 20% of all loans originated in 2005 will have rate adjustments later this year and next, or in 2010. The adjustable rate borrowing didn't end in 2005, and it's no small chunk of the overall economy. L. Baily of the Detroit Free Press (Feb. 17, 2007) explained that 30% of 2006 mortgages were adjustable, and this year, 1.5 trillion dollars of ARMs will adjust. 1.5 trillion dollars! That's like, a whole lot of houses and loans. That's more money than the GDP of most of the world's countries! OK, this may not sounds so bad in abstract, but if you're on the adjusting end of this whole thing, it can mean a lot in terms of monthly outlay. On June 15, 2007, Bob Tedeschi of the New York Times reported, "Many borrowers who took out ARMs in 2004 and 2005 with interest rates in the 5 percent range, for example, will soon face their first adjustment, and their rates are quite likely to rise to the high 7 percent range." So let's break all this down in dollars and cents: Assume you took out a $250,000 mortgage in October 2004, on a 3 year ARM. Your monthly payment was $1,342 for the first 3 years. This month, your rate adjusts to a predetermined rate of prime-plus. Right now, that could be in the 7.5% range. Now, your new monthly payment is $1,748. Outlay for your biggest expense just increased 30%! No problem, you can just refinance, right? Um...possibly not. First of all, you may not be able to afford the monthly payment with a re-fi. Second, with the credit crisis getting deeper each month, lenders who gave money to any borrower with a pulse for the first 7 years of this decade, are suddenly very picky about who they open the purse strings for. OK, worst case scenerio, you sell. Uh, oh! Housing inventory is suddenly very high, and prices are dropping like shooters at Lindsey Lohan's house. And what does this all finally lead to? You guessed it: Defaults, Foreclosures, missed earnings, weeping, a credit crisis, Cramer throwing fits on TV and the mighty USD weakening. And the economy and job growth is still relatively stable. Wait until that gets the sniffles. So Ben Bernanke can rub that salt-and-pepper beard and lower rates until the Bears come home...but until all the ARMs are adjusted (or broken, ha ha!) we'll still have a credit crisis, a bleeding housing market, and a crying Jim Cramer. Make sure you've got the anatacids close by. Also, be sure to check out our blogs, videos, calendar, podcasts, pair analysis, trades, and reports at ProfitingWithForex.com << My Home | The FX Markets Blog Home

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