Household Borrowing and the Mortgage Resets

On Monday, we looked at the upcoming Mortgage Payment Resets; Let’s take a closer look at the data involved, and what this means to the housing and mortgage markets, and the economy at large.

Back of the envelope math on the $2 Trillion worth of Mortgage Resets works out to additional monthly mortgage payments of ~$1.241 Billion per month, per 1% increase in reset rates. That’s about ~$15B in additional mortgage payments per year (per 1% increase).

This $15 Billion is not the key worry, as the economy should be readily able to absorb that amount. Rather, the concern is the much bigger Macro
issue of the economy’s loss of Mortgage Equity Withdrawals — the prime driver
of consumer spending
(for more details see:  Real-Estate Boom Soon May Sputter As an Engine of Retail Sales and GDP w/o Mortgage Equity Withdrawal).

A study by former Fed Chair Alan Greenspan estimated that over $600 billion in cash
out refis took place in 2004; Goldman Sachs estimated that in 2005, home owners withdrew $834 billion.
The estimates are that consumers used between 50% (Greenspan) up to 68% (Goldman Sachs) of that money as discretionary spending.

Over 2 years, that amounts to over a trillion dollars in consumer spending — and THATS a number worth worrying about.

Look at this graphically: The charts below come to us via Northern Trust’s Asha Bangalore. Net borrowing of households was $1204.7 billion in 2005, up from $1023.4 billion in 2004. The 2005 reading is the highest on record:

Total Liabilities, Households:
The no-savings, debt-driven shopping spree: Wheeee!



Since we have been discussing adjustable rate mortgage resets, lets take a closer look at those loans as a percentage of total Mortgages: In 2004 and 2005, adjustables were greater than 30% of all mortgages written:

Arm Loans, by %



But its more than just the resets that are of concern:  According to JP Morgan, the Mortgage Banker’s Association Purchasing Index (MBA-PI) is signaling a pause or future slowdown in housing-market conditions.

Further, they note:

"The average monthly MBA-PI have now declined for three consecutive months through February 2006. The last time that the MBA-PI monthly data declined for three consecutive months was during September 1999. One year later, (i.e., September 2000), housing starts had dipped by 5.3% on a year-over-year basis, which happens to be a very reasonable estimate of what one should expect will occur one year from today . . . One has to go all the way back to September 1999 to find another comparable period in which the average monthly reading of this index actually declined for three consecutive months. Following such declines in this index, housing starts fell by 5.3%, one year later. With such compelling evidence in hand, we remain convinced that a 5% to 6% easing in housing starts over the next year appears to be a very reasonable expectation."

I suspect that JPM is being rather conservative in their estimates of how much New Housing starts could fall off next year. Given the huge housing boom ultra-low interest rates created, I would expect a minimum drop-off of 10-15% was more likely. Depending upon other factors, it could be even more significant that that.

Finally, let’s take a look at the National Association of Home Builders’ Housing Market Index (HMI). In March, it dropped to the lowest reading since November 2001 (The red line in the chart below). HMI is correlated with future sales of new homes — which have dropped in four out of the six months ended January.




Northern Trust notes that: "The survey results suggest that it should not be surprising to see further declines in sales of new single family homes. The index measuring traffic of prospective buyers dropped to 39.0, the lowest since April 2003."

The drop in HMI — from the present lofty levels — suggests that a much larger than 5% decline may be in the offing . . .

UPDATE March 16, 2006 9:56am

Housing Starts declined 7.9% to a
seasonally adjusted 2.120 million annual rate during February, the Commerce Department  reported. Starts had surged 15.8% during what
was the warmest January in roughly a century. Note that this number is notoriously volatile, and should be taken in 2 month averages.

The WSJ reported:  "Building permits fell alongside housing starts in February,
dropping 3.2% to a 2.145 million annual rate. Permits increased 6.8% in January
to 2.216 million.

Homebuilding is widely expected to moderate this year amid higher
interest rates and fading sales rates. The average rate on a 30-year fixed-rate
mortgage was 6.25% in February, up from 6.15% in January and 5.63% in February
2005. Sales of previously owned homes have dropped five straight months and
demand for new homes is well off the peak set last July."




Household Borrowing Gathered Steam in 2005
Asha Bangalore
Northern Trust, March 13, 2006

Housing Market Could Get Homelier
Anthony Chan, PhD.,
Chief Economist, J.P. Morgan Private Client Services
Barron’s, March 14, 2006

Home Builders Survey Signals Noticeable Loss in Sales Momentum
Asha Bangalore
Northern Trust, March 15, 2006

Energy Prices Cool Off, Helping Restrain CPI; Home Starts Slide 7.9%
March 16, 2006 10:07 a.m.

Print Friendly, PDF & Email

What's been said:

Discussions found on the web:
  1. Idaho_Spud commented on Mar 16

    Come gather ’round people
    Wherever you roam
    And admit that the waters
    Around you have grown
    And accept it that soon
    You’ll be drenched to the bone.
    If your time to you
    Is worth savin’
    Then you better start swimmin’
    Or you’ll sink like a stone
    For the times they are a-changin’

    Who’d have thought Bob Dylan knew so much about ARMs in the 1960s?

  2. royce commented on Mar 16

    “Mortgage Equity Withdrawals”? I don’t know who came up with that term or why, but in the real world that practice is commonly known as “borrowing.” Seems like an equity withdrawal would occur only if you sold a portion of your equity to someone else.

  3. Idaho_Spud commented on Mar 16

    Well said royce. If it were really ‘equity withdrawal’ you wouldn’t have to pay interest on it, would you? :)

  4. B commented on Mar 16

    Goldilocks is back. Last time I had a date with her was 2000. She’s older and more haggard looking. But, it sure is funny. All the guys love her more than ever. She’s got that je ne sais quoi that all men love.

  5. Get Long Vega commented on Mar 16

    “Whip out your HELOC, it’s a debt orgy!”

  6. Ben B commented on Mar 16

    this is just too good to be true! lawrence of america is going to be in rare form this evening

  7. D. commented on Mar 16

    According to First American Real Estate Solutions report Mortgage Payment Reset, 29% of first mortgage origination in 2005 have less than 0% equity. If prices drop by 5-10% this number will jump to 48%. This is vs. 7.3% in 1995. We can assume that most mortgages were refinanced in the last few years, so the total number of people with zero equity in their homes is quite high.

    If people can keep on paying their mortgages zero equity is not an issue but the reality is that many mortgages reset in 2006-2007 and homeowners with less than zero equity won’t be able to refiance with higher rates and lower appraisals. The writing is on the wall.

    This will mean foreclosures and upheaval in the MBS market. But who cares, it’s not your problem since the problerm has been outsourced to Japan, China and the UK the great financers who save too much, no? Maybe Bernanke is right… if the Chinese spent more, real estate wouldn’t have gone into a frenzy!

    Listings are ballooning. For example:

    – Las Vegas: low Jan 2004, 3,000; March 12, 17,592

    – Pheonix: July 20, 10748; Dec 30, 27455; March 12, 38184

    – San Diego: Low March 2004, 2301; Dec 30, 14591; March 12, 17685

    This inventory does not include the condos under construction. In Miami there are 25,000 of them, equal to the last 9 years of sales.

    I guess I’m wrong and they’re right, you can’t call it a bubble until it has burst!

  8. jkw commented on Mar 16

    Does anyone know who loses if lots of people start defaulting on their mortgages? Assuming that house prices return to fundamentals, which would basically mean reverting to their 2000 levels plus inflation, someone will lose money. In some cases, it will be the homeowners who just pay off their mortgage anyway. But what about all the people who decide they are just going to default and let the bank deal with it? Banks sold most their mortgages to the MBS market. People claim that the MBS market is backed by the government, but I haven’t seen any clear explanation as to where that claim comes from. If houses fall in value and aref foreclosed on in large numbers, who has to take the loss? Is it the banks that issued the loans, the banks that issued the MBS’s, the holders of the MBS’s, or the government?

  9. D. commented on Mar 16


    Forget the price drop, foreclosures are happening now with no price decline! The key is the resets, the rates and the zero equity. House prices do not need to drop for this to happen. Rates are up and appraisals are down. With the resets, those with zero equity won’t be able to refi. You can’t refi with zero equity and a legal appraisal!

    Homebuilders are still making huge margins. As long as this is the case, they can flood the market with new homes and just cut the price. If you’re one of those hombuyers with zero equity who needs to refi, you’re going to get zinged… if new houses are selling for less than what you paid a year ago, you won’t get the appraisal you need to refi.

    Those holding the MBS paper will get hit. Tell me who’s been picking up this paper and I’ll tell you where the losses will come from.

    All I know, is that a few of months ago I was getting MANY calls asking me to pick up high risk CDOs. With low rates and low credit spreads there’s been an unprecented thirst for yield pick-up.

  10. Anonymous commented on Mar 16


    GSEs (Fannie Mae, Freddie Mac, etc.) own or guarantee just under 50% of the residential MBS market. For conforming residential loans they own about 75%. People like to claim that the MBS market is guaranteed by the government because they can’t imagine our political leaders allowing any of the GSEs to go under. This is essentially a political question, so who really knows.

    I know that with the advent of piggy-back 90-100% LTV loans for purchases and refis over the last ten years that there is much less direct insurance via PMI. So when things start to go bad, they could possibly go really bad. Speaking generally, I think the entire MBS market is sailing into uncharted territory. Let’s hope someone is keeping a lookout.

  11. jkw commented on Mar 16

    If house prices don’t fall significantly, there won’t be substantial losses. Foreclosures alone won’t cause serious problems for the MBS market, because if house prices don’t drop, you can expect to only have a 20-30% loss on each foreclosure. Even if foreclosure rates go up to 10%, that is still only a 2-3% loss. A security that pays 5+% a year can easily take a 3% loss without causing people to sell it in panic.

    However, if house prices fall, foreclosure rates are likely to go up well past 10% and the loss on each foreclosure will be much more than 30%. If you have an average of a 60% loss on each foreclosure (which is likely if house prices in general drop 50%) and you have a 25% foreclosure rate, you have an overall loss of 15%. That might be enough to cause panic selling. If the MBS market dries up, there will be almost no money available for mortgages and house prices will drop substantially more than 50% (in the extreme, if people have to pay cash to buy a house, prices would fall 80% or more, to standard down-payment levels).

  12. D. commented on Mar 16


    the thing is that MBS’s are sold in tranches. And risky tranches are risky. Typically the securitizer keeps the riskiest tranches but not this time… credit spreads have been so low that everything got securitized.

    How do you think the subprime got in and the ARMs and IOs got to see the light of day? Do you really think banks would have been doing this stuff if they couldn’t get them off their books?

    I’m not too worried about the stuff backed by FNM and FRE, it’s the stuff that’s not that is a concern. And if the crappy MBSs tank, FNM and FRE paper will discount higher credit spreads for sure.

  13. GRL commented on Mar 16

    I’d be very curious to have your thoughts on the following two assertions, contained in a recent Citigroup research report on housing:

    [T]here is ample evidence that the resale market is far more overextended than the new home market. In fact, under any scenario of moderating demand over the next few years, we expect housing starts to decline much less than existing home sales.


    In short, our contention is that due to the advent of supply constraints in the mid-90s, the cyclical rise in housing demand this cycle was met primarily through the resale market, rather than the new home construction market. Therefore, it follows that, in any cyclical decline, housing starts should be more stable than existing home sales. We expect this dynamic to emerge beginning this year, as the housing environment moderates to a more normalized level.

    Citi’s contention is that the housing stocks are buys here, and that a serious housing contraction will result in an expansion of the stocks’ multiples on rising earnings as investors come to have greater faith in the companies’ staying power though hard times. In any event, the argument goes, the stocks are so cheap now that any downside is limited, even in a worst case scenario.

    Your thoughts/response?

  14. Altos Research Real Estate Insights commented on Mar 16

    On ARMs and credit card debt

    Northern Trust has published a mildly negative assessment on the state of consumer borrowing.This sharp increase in home mortgages has occurred in a low interest environment. When adjustable rate mortgages are repriced, the debt servicing burden will sh

  15. DBLWYO commented on Mar 16

    And – not to stuff you blog but…. – on your other theses have you looked at consumer spending and earings. YOY % changin in real expenditures and consumer earnings look like earnings (which drive spending) have actually been going down since ’98 !! Spending recovered with the tax stimulas and has held up anomolously with the housing ATM but has shown a very recent and precipitous decline.

    So before we even get to – increased demand for pocketbooks, no more ATM and a huge hit on the only growth sector (& jobs generator) things were already looking less than sanguine from an underlying cyclic structure perspective.

    Excuse me, I stand very corrected. They are in fact quite sanguinary.
    p.s. – graphs and data available on request or you can dload your own from BEA

  16. dsquared commented on Mar 20

    I would not bet the farm on this one (although I suspect that this is exactly what a lot of farmers are doing via MEW). I was pushing a story quite similar to this one with respect to the UK market in 2004 when similar issues began to effect us and it didn’t really work.

Posted Under