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Paul Kiesel
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Prime Mortgages Threaten Potential Housing Recovery

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CNNMoney.com published an article today that reiterates a point I brought up three months ago in a blog titled, “The Next Mortgage Crisis: Prime Borrowers.” CNN’s article relates how more borrowers with good credit (prime borrowers) are defaulting on their home loans, and that’s going to make it even harder for the still slumping housing market to recover.

Here’s what I originally wrote on May 12, 2008:

The time is coming when interest rates will reset in prime loans that were given to people with good credit in the last two years. These resets will have ramifications that are as bad or worse than what’s taken place in the subprime market.

The type of loan that begot the subprime crisis was the “2/28 loan.” It is a 30 year loan, however, the first two years of it included a teaser rate payment option (established through fraudulent TILA forms and lack of disclosure) before the interest rate rose. Except, in many cases, the interest rate rose after 30 days from the origination of the loan. Therefore, people were sometimes, if not often, in a negative amortization loan, expediting the interest reset date. Hence, the subprime mortgage crisis and why so many lenders and servicers have their heads in the sand, and how this has all led to the current onslaught of foreclosures that started to take place six months ago.

Now prime borrowers, too, got loans that began with lower than usual payments and if someone bought or refinanced a home in the past few years, it’s probable that they have one. The “option ARM” loan or “jumbo option ARM” loan (a loan greater than $417,000) will be the downfall for prime borrowers. Both loans give the borrower the option of paying less than what the interest on the loan charges, which is a “negative amortization” loan (also, the words “negative amortization” were not disclosed on most TILA forms, therefore, many borrowers were unaware of the repercussions of this type of loan).

With Washington Mutual, Countrywide, IndyMac, and Golden West (now part of Wachovia), writing well over $500 billion worth of option ARM loans since 2005, it’s scary to see that the mortgage meltdown has already hit California when almost none of these “prime” loans have reset. But they will, and that day is coming very soon, possibly as early as the end of this year.

The CNNMoney article explains how subprime mortgages set the current housing meltdown in motion and Alt-A loans added to the number of defaults and foreclosures. “Now, as prime loans are added to the mix, the resulting foreclosures could haunt the housing market for a long time, according to Global Insight’s Patrick Newport,” (CNNMoney.com, 8/12/08).

On top of the next wave of foreclosures stemming from prime borrowers defaulting, will be the further depreciation of home prices, due to more inventory and foreclosed property coinciding with fewer buyers and tougher lending rules. In fact, the amount of vacant homes on the market (2.8%) is near a historic figure and is up about 50% from three years ago.

Ultimately, the CNNMoney article agrees with my thesis from three months ago: There will be more difficult times ahead before the housing market and lending industry balance and recover.