Coming Soon: Mortgage Payment Resets

You may have missed this over the weekend: The Saturday WSJ reports that "More than $2 trillion of U.S. mortgage debt, or about a quarter of all
mortgage loans outstanding, comes up for interest-rate resets in 2006
and 2007, estimates Moody’s, a research firm in West
Chester, Pa."

Let’s repeat that number:  Over the next 20 months, more than two trillion dollars worth of adjustable rate mortgages will reset at higher interest rates.

Now, I don’t want to be accused of being a perma-bear or anything like that, but I am having a hard time trying to figure out exactly how anyone can spin this into a positive: Dark matter? Credit Surplus? Real Estate Boom?

I’m at a loss for words spin.

Perhaps a chart may help: Not only do we have a significant mortgage debt reset acomin’, but a huge chunk of it is subprime. That means the debtor’s are those least able to handle the monthly increase. Nice. 

"Millions of Americans who stretched themselves financially to buy homes face a painful adjustment — some could even lose their houses — as monthly payments on adjustable-rate mortgages are reset higher.

In the hot housing market of recent years, many households took advantage of "affordability" mortgage loans — heavily promoted by lenders — that hold down payments for an initial period. Now the initial periods are coming to an end on many of these loans, leaving borrowers to face resets of their interest rates that can cause monthly payments to shoot up between 10% and 50% . . .

Resets will "eat into discretionary spending" for many Americans, says Joshua Shapiro, chief U.S. economist at MFR Inc., an economic consulting firm in New York. He expects consumer spending to slow in the months ahead but says the job market remains strong enough to keep most people out of serious trouble."


Sure, that sounds pretty bad, but how awful can it be? Well, the worst case scenario is a wave of defaults, foreclosures, and forced sales, forcing home prices appreciably (depreciably?) lower.

Hopefully, many of the defaults will refi and avoid foreclosure. (Gee, I hope Carmella’s Spec house wasn’t variable mortgaged).  But the macro impact will clearly be on consumer spending; Not only will this group of non-saving, free spending consumers have their budget’s crimped by their increased mortgage costs, but their ready source of equity to borrow against goes buh-bye. This does not end well . . .   

One title insurer ran the numbers, and they project that of the adjustable rate mortgages written over the past 2 years, as many as 1 in 8 (12.5%) will end up in default:

"Most borrowers will be able to cope with the coming wave of resets, in
some cases by refinancing with new loans, lenders and mortgage industry
analysts say. But some borrowers will have trouble meeting the higher
payments and may be forced to sell their homes or could lose their
homes to foreclosures. A recent study by First American Real Estate
Solutions, a unit of title insurer First American Corp., projects that
about one in eight households with adjustable-rate mortgages that
originated in 2004 and 2005 will default on those loans."

Its hard to imagine how without a significant uptick in economic activity, (by definition) a recession is unavoidable no later than the end of 2007. We believe that when looking back in hindsight from 2008, there’s a very real possibility that the recession will be marked as beginning towards the end of 2006.

If and when this happens, there are two classes of goats for the lynch mobs to single out: Those clowns who insisted that the U.S. savings rate is not actually negative (thanks to home appreciation!), and those members of the sunshine crowd who insist that this imbalanced structurally unstable, economically disparite economy was just fine.

If you think Santa’s list of who’s been naughty and who’s been nice is tough, just wait until you see mine . . .


UPDATE: March 15, 2006 5:49am

A quick back of the envelope calculation shows that the resets results in an additional monthly mortgage payments of $1.241 Billion per month per 1% increase, or ~$15B in additional mortgage payments per year per 1% increase.

That’s not insignificant, but it is dwarfed by the much bigger macro issue of the loss of cash out refis — which have been a major driver of consumer spending.

Former Fed Chair Greenspan estimates that over $600 billion in cash out refis took place in 2004 — that dwarfs the increase in monthly payments.  Goldman Sachs estimates that in 2005, it was $834 billion. The expectation is that consumers spent 68% of that money.

For more details see:  Real-Estate Boom Soon May Sputter As an Engine of Retail Sales and GDP w/o Mortgage Equity Withdrawal


Millions Are Facing Monthly Squeeze On House Payments
Many Adjustable-Rate Loans, Popular in Recent Years, Will Soon Be Reset Higher
WSJ, March 11, 2006; Page A1

Do Homeowners Know Their House Values and Mortgage Terms?

First American Real Estate Solutions, Feb 14, 2006

Mortgage Payment Reset: The Rumor and the Reality
Christopher Cagan, Ph.D
First American Real Estate Solutions

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What's been said:

Discussions found on the web:
  1. Idaho_Spud commented on Mar 13

    I’m for lynching any enabler who funded a zero-down no-doc loan or neg-am loan. Right now.

  2. royce commented on Mar 13

    If there’s no housing bubble, Barry, there’s no reason to worry about this. People who default will just sell their houses at a small loss to people with the money to buy them (because prices won’t fall much- since there’s no bubble and houses are fairly priced). The sellers will then be able to redirect their earned income into other assets or towards consumption, pumping up economic growth.

    Personally, I don’t believe this. But I believe in the bubble, so I don’t have to.

  3. kdawg commented on Mar 13

    Refers back to the the NY Times article in June :

    Let’s look at it the Southern California way. According to Businessweek 1/3 of the jobs created in San Bernardino County last year were construction related. According to the Orange County Register 1/4 of jobs created in O.C. were real estate finance related.
    L.A. Times reported that the median house in the San Fenando Valley was $600k which could be said for other parts of L.A. too.

    O.k. Simple math here. Taking the aforementioned S.V. median house on a conventional mortgage at 20% down that’s a $120k down payment. Considering that the U.S. median income is $43k and the savings rate is zero – Who then has the $120k sitting in the bank on a 2 family income ?

    The calulations from that same LA Times articles states that you’d need household income of around $150k to support a conventional loan on that median S.V. house. Ummmm….the median household income is coming up a little short. So where have these home buyers turned to propel L.A. home prices higher ? You guessed it. ARM and IO loans and might account for a good chunk of those $2 trillion in resets.

    Considering the reliance on R.E. jobs and activity you could say that L.A. could get hit pretty hard in the next few years.

  4. KL2005 commented on Mar 13

    Yes, but the Nasdaq bubble forced the feds hand. If not for easy money it would have been 1929 all over again.

    Of course it has been easy money since the 1980’s but, the fed is not yet ready to face (or even admit) that excessive mortgage and credit card debt are the problem.

    So the fed’s hand is forced and we will continue to see the can kicked down the road until someone decidedes to acknowledge the true problem. There are two ways out 1930’s or 1970’s all over again. The question is how long until the solution????

  5. erikpupo commented on Mar 13

    I dont think u can look to refinancing loans as a solution here. Most of the people who took out these adj mortgage loans did so because they couldnt afford the payments under a reg loan. What makes people think they could even refinance, especially at higher rates. If they couldnt pay when rates were low, there is no way they could pay now when rates are higher.

  6. Idaho_Spud commented on Mar 13

    Looks like congress pushed the new bankruptcy law through just in the nick of time to salvage the financial community. I guess with Greenspan leaving they needed some other sort of insurance against their risky behavior.

  7. B commented on Mar 13

    And what a way to celebrate with the Housing Index leading the charge to the upside this AM being up 1.2%. Doh!

  8. trader75 commented on Mar 13

    As that wisecracking comedian Bertrand Russell once noted: “Most men would rather die than think. In fact, they do so.”

    To borrow a Big Picture phrase, the markets are about to ‘get Darwinian’ on Joe Homeowner.

  9. trader75 commented on Mar 13

    As a bonus, we have pissed off Dubai and the petrodollar crowd just in time for foreign holders of US Treasuries to do max damage when they start disgorging their holdings. Hammer Time, coming to a long bond near you.

    Nice to see 30 year rates near 18 month highs as all those “2/28” loans kick in — adjustables that reset to the prime rate EVERY SIX MONTHS FOR THE NEXT TWENTY-EIGHT YEARS. Good Lord!

    Doctor Evil himself would be hard-pressed to come up with a more nefarious financial destruction device.

  10. KirkH commented on Mar 13

    Frankly, I don’t understand why the feds let the low-rate party go on for so long – it was pretty obvious to me in summer of 2004 that rates needed to move up to short-circuit any further real estate bubble. It was already pretty evident at that time.

    Because, according to the Fed, there is no way to know you’re in a bubble until after it pops because nobody would buy if they knew they were in a bubble. It sounds like they’ve never heard of the greater fool theory or speculation or tulips.

  11. B commented on Mar 13

    Billions in mergers announced and the Broker/Dealers Index is rolling over. DeMark sell on the monthly and weekly with price action follow through last week. It was fun while it lasted. X marks the spot. And this morning on CNBC they have two analysts on talking up the sector. Of course, we have no idea what their track record of correct calls is………… just need to have a heart beat and be positive to be on CNBC.

  12. Anonymous commented on Mar 13

    Just a reminder, for what it’s worth… on February 23, 2004, Chairman Greenspan spoke to the Credit Union National Association 2004 Governmental Affairs Conference. His speech covered a broad range of topics, including mortgage financing. Here’s what he stated about the ARM mortgage:

    “Recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward.

    American homeowners clearly like the certainty of fixed mortgage payments. This preference is in striking contrast to the situation in some other countries, where adjustable-rate mortgages are far more common and where efforts to introduce American-type fixed-rate mortgages generally have not been successful. Fixed-rate mortgages seem unduly expensive to households in other countries. One possible reason is that these mortgages effectively charge homeowners high fees for protection against rising interest rates and for the right to refinance.

    American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.”

  13. Joe commented on Mar 13

    Barry, nice post on this subject. I do have a question. If 2 Trillion is coming up for reset in 2006 and 2007, can you compare that number to 2004 and 2005? I just don’t have a handle on how much more money this is over what is “typical”. Sounds like a lot of money, but is this 50% over the last few years, or less?


  14. JoshK commented on Mar 13

    I thought that most of these adjustable loans protect against more than a 1% per year ratchet up?

  15. anon commented on Mar 13

    once again, this is a reactive comment by the media and those reporting it than a proactive investment decision that should have been made months ago. this story has been out there for months. Read David Kotok’s (Cumberland Advisors) brilliant commentary on this topic from last year.

    This is the problem in the market. Too much reaction and little pro-action. Stay bearish Barry, you will be right.

  16. Barry 2.0 commented on Mar 13


    First off, my name is Barry too. 2nd off, just tell me when
    this market is gonna crash. That’s why I read ‘the Big Picture’.

    I e-mailed Random Roger and he totally blew me off and said these things are hard to call.

    Do it man – I’m sick of this market moving up and sideways.

    I need to see some downside action.


  17. Roger Nusbaum commented on Mar 13

    I don’t know = I blew you off??


  18. Larry Nusbaum, Scottsdale commented on Mar 13

    Barry, First off, my name is Barry too. 2nd off, just tell me when
    this market is gonna crash. That’s why I read ‘the Big Picture’.

  19. Larry Nusbaum, Scottsdale commented on Mar 13

    I agree (once and only) with Greenspan on the fixed rate vs the ARM. The 30 year loan is a rip-off product. Period.

  20. Jay Walker commented on Mar 14

    OK, I have to disagree with the comment re: 30 year loan. Why not give the consumer the right of choice. Here in Canada, the banks got rid of these years ago. About the only thing you can get is a 10 year term.

    I sometimes look wistfully at the US market – especially when rates are at a generational low – I’d loved to have maxed out my financing a year ago (when I actually did refi my mortgage here) at those 30 year rates.

    I used to see people come into HFC when I worked there with these low 6% mortgages from the late 1960s/early 1970s and thought “HOW SWEET”.

    Trust me, in a couple of years, everybody who’s bemoaning these as a rip-off is going to have a contrarian view of this: it all depends on whether the underlying economics favor rates moving up for a long period (as they do now), or down (as they did through the 80s and 90s).

    My 2 cents

    Jay Walker
    The Confused Capitalist

  21. Anonymous commented on Mar 14

    As Greenspan points out, over the last couple of decades the fixed-rate loan was costly to consumers vs. an adjustable-rate. If we are now living in a rising interest rate environment, this will no longer be true… but who really knows. I long ago gave up predicting where interest rates might be long term.

    There is nothing inherently wrong about the 30-year mortgage. It’s just like insurance. If you want a lot of insurance, buy it. Are many Americans over-insured? Probably. It’s not the product that’s bad, just how many use it.

    We should also separate the issues of rate and term. There’s nothing wrong with a fixed rate. I think anyone would take a fixed rate over a comparably priced adjustable. The problem is with the length of the term, and the correspondent amount of interest paid. Is a 15-year loan better? Sure, if you can afford the payment. 10 year is even better still.

    But it seems we’re now heading in a different direction with rising rates and the new 40-year terms now being promoted by lenders.

  22. Larry Nusbaum, Scottsdale commented on Mar 14

    The 30-year fixed rate loan is a consumer rip-off.
    ARM are better than fixed.
    However, the job of the consumer and the lender is to match the right loan with the borrower. That is not an easy task because lenders do not ask the right questions and borrowers don’t know the answers.

  23. Suresh commented on Mar 14

    Back in December, Mike Shedlock had a great article on rate resets, which can be still be found at The last chart in his article compares the rate resets by year of subprime, jumbo, alt-a, and PCC.

    Mish’s work is consonant with Fannie Mae Chief Economist David Berson’s comment some time ago. Mr. Berson said that fewer than 10 percent of the conventional conforming loans will reset in 2006-2007, but nearly two-thirds of sub-prime loans will. That is because a large portion of the sub-prime loans are two-year adjustables.

  24. Paul commented on Mar 15

    Can we quantify what these mortgage resets mean to consumer spending? I remember all the talk as oil ran up in ’04 and ’05 that every $1 increase in oil resulted in a ‘tax’ on consumers of $xx billion (fill in blank). So what about mortgage resets? So I took a stab at it with what is undoubtedly an overly simplified, and quite possibly flawed, analysis. (Hey, it’s been awhile since my MBA/CFA studies, so cut me some slack!) Anyone have any other info or a better way to perform an analysis, please respond!
    I used a standard loan amortization table, plugged in a $2trillion mortgage at 5% for 30 years or 360 months. This resulted in a monthly payment of $10.692 billion. Increasing the rate up to 5.25% resulted in a $10.996 billion monthly payment, or an increase of $304 million per month or $3.65 billion annually. Tony Crescenzi states on that consumers faced an extra $70 billion in energy expenses in ’04. I’m guessing the increase in ’05 was more.(?) So if my analysis is anywhere in the ballpark, a 1% average reset results in $15billion in extra mortgage payments over the next year. Not a huge number on a macro scale compared to oil increases in ’04 and ’05, Bush’s tax cuts, etc. However, if you accept that the tax cuts primarily benefited the upper classes, and keep in mind that the mortgage resets will likely affect the lower classes or financially stretched (combined with higher energy bills), the impact could be significant. (Sorry this post is so disjointed.)

  25. Larry Nusbaum, Scottsdale commented on Mar 15

    “However, if you accept that the tax cuts primarily benefited the upper classes, and keep in mind that the mortgage resets will likely affect the lower classes or financially stretched (combined with higher energy bills), the impact could be significant.”

    Paul: I don’t accept that statement. What was it based on?

  26. Credit Card Debt Help commented on Apr 27

    I dont agree with the tax cuts benefiting the upper class as much as I would agree that having them put in place dosent take away more from what they have earned.

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