Subprime adjustable rate mortgages are resetting in record numbers

That’s the $25,000 question as we roll in to 2008, and the highlight of today’s Wall Street Journal report on the ramifications of adjusting adjustable rate mortgages on the housing market. The stunning figure is the total number of mortgages resetting each and every month. The White House pegs the number at over 150,000. That breaks down to:

5,000 loans resetting every day
208.3 loans resetting every hour
3.5 loans resetting every minute

This torrid pace is only expected to continue through the first half of 2008, with devastating consequences to the housing market.

Banc of America Securities, a unit of [Bank of America], estimates that $85 billion in subprime mortgages are resetting during the current quarter, and the same amount will reset in the first quarter of 2008. That will rise to a peak of $101 billion in the second quarter. The estimates include loans packaged into securities and held in bank portfolios.

Larry Litton Jr., chief executive of Litton Loan Servicing, says resetting of adjustable-rate mortgages, or ARMs, has recently emerged as a bigger driver of defaults. “The initial wave was largely driven by a higher frequency of fraudulent loans…and loose underwriting,” says Mr. Litton, whose company services 340,000 loans nationwide. “A much larger percentage of the defaults we’re seeing right now are the result of ARM resets.”

These defaults are quickly becoming a major part of the housing market picture; adding up to 4 months worth of new housing supply to an already over-saturated market. What’s worse is that these foreclosed homes sell at a steep discount – some auctions in San Diego were seeing 33% price reductions at final sale – driving down sales prices and limiting options for home owners in the area.

The Mortgage Bankers Association estimates that 1.35 million homes will enter the foreclosure process this year and another 1.44 million in 2008, up from 705,000 in 2005.

The projected supply of foreclosed homes is equal to about 45% of existing home sales and could add four months to the supply of existing homes, says Dale Westhoff, a senior managing director at Bear Stearns. This is a “fundamental shift” in the housing supply, says Mr. Westhoff, who believes that home prices will drop further as lenders “mark to market” repossessed homes.

Foreclosed homes typically sell at a discount of 20% to 25% compared to the sale of an owner-occupied home, analysts say. Lenders are eager to unload the properties, and the homes tend to be in poorer condition.

This is the chain reaction that is literally boxing home owners in. I talked about my neighborhood as one example where a couple of units headed to foreclosure has dragged the comparable sales down from the mid-600’s to the low 500’s; putting even those who put down 20% (like me) in a very tenuous position (to say the least).

So what does this mean? It has a couple of implications:

If you are a home owner with an ARM that is set to adjust any time soon, it’s time to get moving on how you’re going to tackle that problem.
If you are a home owner who is thinking about refinancing any time soon for a strategic reason, it’s time to get moving before your neighbor gets foreclosed on and wipes out your ‘equity’ with a comparable sale that will make you blanch.

For those of you in group 1, read this article on how to combat an adjustable rate mortgage reset. For those of you in group 2 you may want to consider this piece on ‘protecting’ your home equity with a home equity line of credit; and if you don’t know if you have an adjustable rate mortgage, watch this video on how to examine your loan documents to find out if you have an ARM or not.

What do you think? How bad will this surge in resets be for the housing market, and how will it compare to the upcoming Option ARM reset wave?