http://www.azcentral.com/news/articles/0505mortgage0505.html

Risky ARM mortgages come due

Catherine Reagor The Arizona Republic May. 5, 2006 12:00 AM

Higher mortgage payments are squeezing more homeowners.

Not because they've bought bigger homes or tapped their equity by taking out second mortgages but because the superlow "teaser" payments that drew them into their adjustable-rate mortgages are quickly disappearing.

Thousands of people used the non-traditional mortgages last year to afford a house in the Valley, where home prices increased nearly 50 percent from 2004. They're paying for that decision today.

On many adjustable-rate mortgages, or ARMs, the interest rate adjusts twice a year after the teaser period.

As a result, each year, the monthly payment on a loan for a $250,000 Valley home could climb by more than $100.

Arizona incomes aren't climbing at the same rate, meaning many of those already struggling to pay their mortgages could wind up losing their homes in the months ahead.

Arizona's housing market could be hurt more than other areas of the country by a fallout from rapidly rising rates on ARMs.

Economists say nearly 40 percent of all home loans in metropolitan Phoenix are adjustable. Nationally, about 30 percent of all mortgages are ARMs.

Making the situation potentially worse for Arizona's housing market, the number of subprime ARMs jumped by 50 percent in the state last year, the Mortgage Bankers Association of Arizona reports. Subprime loans, which carry high interest rates, typically are taken out by borrowers with poor credit histories.

Adjustable-rate mortgages offer low introductory interest rates that quickly and frequently climb based on a rate and index set by the lender. Unlike traditional, fixed mortgages, those indexes are closely tied to the interest rate that the Federal Reserve has hiked 15 times in the past two years.

"Record numbers of people lured by low initial teaser rates have taken out adjustable-rate mortgages that are putting them in vulnerable positions as rates rise," said Jay Luber, a vice president with First Horizon Home Loans in Phoenix.

Refinancing ARMs

Some homeowners, like Mary and Michael Gotway of Paradise Valley, are now refinancing their adjustable-rate mortgages and converting to traditional fixed ones before their payments jump.

The Gotways had an initial interest rate of 5 percent when they purchased last summer, but they noticed that it would soon start adjusting.

"We saw rates were going up and what that would do to our payment," Mary said. "We decided we needed to do something fast."

The couple refinanced to a 30-year, fixed-rate mortgage with an interest rate slightly below 7 percent. Their payment will climb a few hundred dollars a month with the new loan, but it would have jumped almost twice that much in the next few years under the terms of their ARM.

Some people don't pay as much attention to their loan documents and don't even realize how much their payments will climb until they get their mortgage statement.

Then, they are stuck making the higher payments until they can refinance. Some in subprime loans don't have high enough credit scores to refinance to a lower rate mortgage, so they are stuck.

"Many people out there with adjustable-rate mortgages don't have any idea when their rates will go up," said Terry Turk, president of Sun American Mortgage. "Those are the people who are going to get hurt."

Falling behind

The number of people making late payments on ARMs in Arizona climbed during the second half of 2005.

At the end of the year, almost 10,000 homeowners across the state were behind on their payments for adjustable mortgages. That is almost double the rate from last summer, according to the Mortgage Bankers Association of America.

It's easy to see how people fall behind.

Rates on one-year, adjustable-rate mortgages are hovering around 5.7 percent, almost a percentage point less than a 30-year fixed mortgage, which hit 6.59 percent Thursday, the highest level since June 2002.

But the interest rate on a one-year ARM can go up as much as 2 percentage points a year. So someone who takes out one of those mortgages today could see his or her mortgage rate hit 7.8 percent next spring, which would erase all the savings of the past year.

The monthly payment on a $200,000 mortgage would climb from $1,167 to $1,432 with that rate jump.

"Teaser rates are very misleading," said Jay Butler, director of the Arizona Real Estate Center at Arizona State University Polytechnic. "People hear that they can get a 4 percent rate, which allows them to afford a home. But then they stop listening."

A Federal Reserve study this year found that 41 percent of homeowners with adjustable loans didn't have any idea about the maximum interest rate they could be charged.

About 17 percent of those homeowners polled didn't know how often their payments could change with an ARM.

Federal banking regulators want to make lenders better educate borrowers on adjustable-rate loans and their ability to afford one.

Joann Hauger of Community Housing Resources of Arizona said that the problem for people with ARMs is just beginning and that housing groups like hers are expecting to get many calls for help in three to four months.

Making matters worse for those homeowners who can't make higher ARM payments or refinance fast enough is a slowing real estate market.

Now, it's more difficult to sell a home quickly or make enough off a sale to pay off a home than it was during last year's housing-appreciation frenzy.

Foreclosures follow

Last year, strapped homeowners were able to sell quickly for hefty profits or refinance into ARMs with artificially low teaser rates. As a result, foreclosures were at nearly record lows.

But now, a growing number of people are so stretched they are spending more than they earn.

First American Real Estate estimates that $297 billion worth of adjustable-rate mortgages issued nationally in 2005 and 2004 could end up in foreclosure.

Overall, U.S. mortgage delinquencies rose to 4.7 percent at the end of 2005, their highest level since mid-2004.

Arizona's delinquency rate was 3 percent at the end of last year, low by national standards and the 3.7 percent state rate from 2004. People falling behind on their mortgage due to the devastation of Hurricane Katrina pushed up the national delinquency rate.

The Valley's hot housing market in 2005 helped pull down the local rate.

But foreclosures in metropolitan Phoenix are already beginning to climb.

"If interest rates continue to go up and housing prices don't, more people will be squeezed," said Elliott Pollack, an Arizona economist and real estate investor.

"When the next recession rolls around, many people are going to be set up for a very bad situation."