Spike in Defaults Looming: Remaining Interest-Only Alt-A Loans Set to Recast to Full Payment of Principal and Interest
The looming recast to full payment of principal and interest for the remaining interest-only Alt-A loans in 2006-2007 vintage private-label RMBS is expected to drive default rates up again in 2016-2017. Moody's suggests that the spike in default rate will be less severe than that seen in 2015, but a larger portion of loans will be subject to recasts.
So the resets are expected to drive defaults up, but less than 2015, even though a larger portion of loans will be subject to recast? How can that be?
"Defaults on Alt-A IO loans with an IO period expiring in 2016-2017 will rise when they recast to full payment of principal and interest, owing to an expected future increase in monthly mortgage payments. However, default rates will likely stay below those of Alt-A IO loans which re-casted to full payment in 2015 because of a slightly smaller expected payment shock and slightly better borrower credit profiles," the agency observes.
Oh, thank goodness. Slightly smaller payment shock and slightly better borrower credit profiles. Whew, I was really worried there for a second. Good thing these homeowner have a slightly better credit profile than their predecessors.
Payment shock is anticipated to remain most significant for three-year, five-year and seven-year ARMs in 2016-2017, but the three cohorts will also likely register the most substantial declines from 2015 levels. Further, 2006-2007 vintage 10-year Alt-A IO loan borrowers who have remained always-current, on average, have higher original FICO scores (720 and 723) than their 2005 counterparts (700). Consequently, the remaining always-current loans for 2006 and 2007 - being of higher credit quality than those in 2005 and likely to experience lower payment shocks when they recast in 2016-2017 - are expected to default at slightly lower rates.
Wait a minute, 720 and 723 FICO scores vs 700 a FICO score. Whats the difference? They are both highly rated credit risks. According to Credit.com a Good Credit score = 700-749. Well, at least this round of potential "deadbeats" will likely experience a lower payment shock from their 2005 counterparts, right?
Roughly 47% of 2006 vintage Alt-A loans and about 57% of 2007 loans will have 10-year IO periods that expire in 2016-2017, with half of those borrowers subject to monthly payment hikes of 50%-70%. ARMs with 10-year IO periods account for roughly 24% of 2006 Alt-A loans and 26% of 2007 loans, compared with just 16% of 2005 loans.
Whoa! 47% of 2006 loans and 57% of 2007 loans are about to recast with half of them subject to 50%-70% hikes! Holy shit! So, on a typical loan in Florida, for $250,000 with an interest only payment of $1250 at 6% that payment would reset upwards about $750 (60%) to approximately $2000. Add on taxes, about $3,000 a year and home owners insurance, about $2,500 a year, if your lucky, and you would be looking at a $2,500 mortgage payment. Oh, and lets not forget, most communities in FL have HOA dues on average of $350 bringing your total cost of "owning" the home to $2,850 per month. Hope they don't have a second mortgage as well since they would most likely be recasting at the same time of the first mortgage!
The default rate on 2005 Alt-A 10-year IOs, on average, nearly tripled - rising to 10.1% in March 2016 from 3.4% in March 2015. The monthly principal and interest payment for 10-year Alt-A IOs, on average, increased by US$421 (or 37.2%) to roughly US$1,553 in March 2016 from US$1,132 in March 2015. By comparison, the average non-IO Alt-A loan's average payment was US$1,237 in March 2016.
Well that makes sense. The reason the default rate went up on the 2005 Alt-A's from March of 2015 to March of 2016 is because the payment shock had not occurred yet or, if i did, you have to give the "deadbeats" enough time to deplete all of their saving trying to save their home through a "modification" before they default, right?
Moody's believes that several macroeconomic factors will help temper the potential rise in default rates, including: low unemployment and growing wages; rising home prices; and broader use of loan modifications.
Well, I'm glad Moody's believes this time the effect of the defaults will be tempered since the country is gainfully employed with wages rising every day! That should cover the looming 50%-70% payment hikes! If that doesn't work out, the homeowner can always refinance, being that home prices are up, or simply get a loan modification.