Rising ARMs May Upset Housing Market
RENEE MONTAGNE, host:
With new home prices falling, more people were buying last month. Government data on sales in September showed a number of new homes sold is up for a second straight month. However, the median price was down nearly 10 percent. That's the biggest drop in more than 35 years. And there've been lots of stories lately about what will happen to the millions of people who've taken out adjustable rate mortgages or ARM's.
The combination of rising interest rates and a cooling market has left many people with higher loan payments, but also unable to sell their properties for what they paid. This has led to a forecast of a collapse in housing that could bring down the entire economy. But many economists say that's unlikely.
NPR's Jack Speer reports.
JACK SPEER: For months now, there have been dire warnings about what will happen when the bottom falls out of the housing market.
Mr. CHRISTOPHER CAGAN (Director Of Research, First American Real Estate Solutions): The rumor is that adjustable resets will overwhelm and break the real estate market. It's the great tidal wave of the century.
SPEER: That's Christopher Cagan, director of research at First American Real Estate Solutions, who doesn't expect that will happen. Cagan looked at data from around 26 million home loans. He estimates will be around 750,000 real estate foreclosures over the next five years. That's a big number, but it's a small fraction of all the real estate loans out there. And as the interest rate on adjustable rate mortgages rises, people are doing pretty much what you would expect, looking at their options. Jenny Ferguson is a mortgage broker in Pleasanton, California, an hour outside of San Francisco.
Ms. JENNY FERGUSON (Mortgage Broker, Pleasanton, California): We're seeing a lot of people that are coming in with ARMs, that are looking to get out of those ARMs. Or we're seeing a lot of people with home equity lines of credit that are also looking to get out of those and get in to something fixed.
SPEER: She acknowledges there are plenty of people who use risky loans to buy way more house than they could afford who will wind up being forced to sell, in some cases at a substantial loss. But she doesn't sense that's what will happen in most instances.
Ms. FERGUSON: The people that I have calling me are not in panic mode. A lot of them are saying: I'm going to bite the bullet, and I'm going to pay the prepayment penalty. Just get me out of this, and get me into something more stable.
SPEER: There's no doubt adjustable rate mortgages are more common these days, about a third of all of the home loans taken out in the last two years were adjustable, and the percentage is much higher in cities along the East and West coasts.
However, people forecasting problems for the economy - including recession because of the increased use of adjustable rate mortgage loans - are probably painting too dire a picture, according to Mike England, chief economist at Action Economics.
Mr. MIKE ENGLAND (Chief Economist, Action Economics): The more alarmist descriptions that operate on the basic assumption that households are not smart. When they liberate cash, they spend it immediately. And when they commit to mortgages, they adopt a low-interest payments up front with it, which they can just barely make. And then when interest rates rise they're financially crashed, this is not the way most people behave.
SPEER: And it's that rational behavior on the part of consumers, economists are counting on. As interest rates rise on adjustable rate loans, they say some mortgage holders, who opt to pay several hundred dollars more a month for the certainty of a fixed-rate loan, or refinance into another adjustable rate mortgage. But England says the thing that the majority of people won't do is turn their house keys over to the bank.
Mr. ENGLAND: Most default rates on mortgages are small, single digit numbers, even throughout the cycle - though obviously it always trends up at the end of a business cycle - and is probably happening in this cycle as well. Those rates are relatively low. And the large majority of people don't find themselves in default situations with their mortgages.
SPEER: According to the Mortgage Bankers Association, fewer than one percent of outstanding mortgage loans are now in foreclosure. A number that is well within historical averages, but an increase in the number of defaults is not the only way the economy could be derailed. Many economists worry about the so-called negative wealth effect - what would happen if home values dropped enough to make even wealthy people reduce their spending. Economist Chris Cagan says he sees little evidence of that yet. Overall, home equity hasn't dipped much, even though some markets are showing substantial declines in home prices.
Jack Speer, NPR News, Washington.
MONTAGNE: And where will home prices fall next? Get projections for selected cities across the country at NPR.org.