Mortgage Resets

Refinancing peaked exactly 5 years ago this month.

A major issue that has contributed to falling prices in real estate is the use of refinancing to "cash-out" equity from a house. Essentially, a second mortgage was taken out and could be a credit line or a lump sum payment. Consumers were encouraged by low interest rates and their home's skyrocketing price to go ahead and splurge: Buy a new SUV for your family. Take that needed vacation. Add on a fourth bedroom. After all, you deserve it Mr. and Mrs. American!

Taken October 17th, 2007 at Bank of America.

And consumers certainly did take out money from their home's ballooning values, many using variable rate loans that would increase at a later date (5 years being the most popular.) In a large number of cases, these loans were taken out with no proof of the borrower's ability to pay the reset rate. The house's increasing price would be the collateral. These new mortgages were then commoditized on the financial markets as various financial products, and sold to investors of all types.

Mortgage resets are peaking this month. (March 2008)

Now, borrowers are confronted with the price of this borrowed prosperity. Real wage growth has remained stagnant, and now the bills are going up (reset mortgage payments) and the property's market value (the collateral) is going down.

So when will the worst pain be felt through the housing markets? I estimate that the price deterioration will be steepest at about 6-8 months past the mid-2008 time period. This is after most of the resets will have taken place, and by early 2009, most of the homes that will be lost due to resets in this cycle will already have been evicted and sold, or at least on the market bringing prices down overall. We could see prices begin to curtail their fall, and perhaps even rise again, sometime in 2009.