The San Francisco Chronicle is reporting that a recent study estimates that more than $30 billion in so-called “option ARM” resets in the Bay Area are due to hit the foreclosure stats next year.  (If the above link has expired, I have uploaded a reprint here.)  If you are one of the borrowers who fit into this difficult spot, you probably already know it. For those who don’t, here’s a brief primer.

An “Option ARM” is an adjustable rate mortgage that includes a feature which allows the borrower to decide whether he is going to pay just the interest or interest and principal.  There may be other flavors, variations or exotic trim packages, but that’s the basic idea: Borrower gets to choose the payment that they will make in any particular month. The problem with most of them is that they usually include a negative amortization (or “neg am”) risk, meaning that, if the borrower elects to make the minimum payments, the amount of the outstanding principal actually increases over time. So with housing prices declining and loan balances increasing, you have the perfect storm for a home loan disaster.  Whether it’s a whole new home loan disaster or just a continuation of the one we’re already in, well, I’m not sure that we need to slice it that thin.  In  short, more bad news coming.

The Chronicle article, written by Chronicle staffer Caroline Said, lays the problem out nicely, and does a good job of showing what’s on the horizon.  It’s not pretty.

To wit, the following frightening statistics:

  • Bay Area Mortgages written between 2004 and 2008 that have the Option ARM feature:  This varies by county, but the high is in Solano County, at 28.12%, and the low is in the San Francisco/Marin/Alameda/Contra Costa and San Mateo cluster at 19.52.  One fifth AT LEAST.
  • The percent of these loans that are either already in default or foreclosure, again varying by county, is a low of 27.23%, and a high of 36.91%
  • The average loan value across the 9-county range is $584,000, so we’re not talking studio condos. This is a problem that is going to hit the higher priced neighborhoods.
  • Total outstanding loan balance: $30.9 billion.
  • Borrowers who make the minimum payments? 94%  Eeek.  That is a scary number. And to my mind, it suggests that most of these properties are seriously under water and that the minimum-payment syndrome is a rent-paying strategy designed to buy time and make room for an unlikely “hail Mary option” to miraculously show up on the doorstep.
  • And the two most jarring stats: Average loan-to-value ratio at time of loan inception: 79%. Average now? 126%
  • 9-County figure of Option ARM borrowers who are delinquent now? 39.3%.

So what does all this mean? It’s pointless to try reading tea leaves with information like this, but it seems pretty clear that the Bay Area has a long way to go before our housing market is completely out of the woods. It’s very hard to believe that all of these loans are going to cure without some very painful side effects, like bankruptcies, foreclosures and other “rip cord” type solutions, hitting a higher income bracket than ever before. People who borrow a half-million dollars aren’t used to the word “bankruptcy” being in their day-to-day lexicon.

And what if you’re a homeowner who falls into this picture? Well, that’s beyond the scope of this little blog. But the question that presents itself is the same one that has been presenting to many, many other folks in the last couple of years: How underwater are you, and how long do you want to keep dumping good money after bad? To me, in most instances, the problem isn’t much more complicated than that.  The hard question isn’t what to do, it’s more a matter of when to do it and whether there are planning steps that can or should be considered.

There is no on-size-fits-all solution to this problem, and your strategy is going to have to depend on a very careful and detailed analysis of your total financial picture.

Do you need to see a lawyer? Maybe, but I wouldn’t start there. I’d start with an accountant and an appraiser to get the best picture of your exposure. The legal decisions after that are easy. In fact, the legal decision will probably be obvious once the true facts are known. What do you have? What do you owe? What do you want to do about it and are there any timing issues that need to be considered?

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