Mortgage Payment Reset: The Issue and the Impact

Trillions of dollars of adjustable-rate mortgages will have their payments begin to reset in 2007 and 2008, or have begun to reset already. What will be the impact of mortgage payment reset on the mortgage lending industry and the national economy as a whole?

Dr. Christopher L. Cagan, director of research and analytics for First American CoreLogic, has conducted a comprehensive study to determine what impact mortgage payment reset and changes
in the real estate market may have on payment increases and upon default and foreclosure. The study projects 1.1 million reset-related foreclosures, spread out over a total period of six to
seven years. This represents 13 percent of the adjustable-rate mortgages originated through purchase or refinance from 2004 to 2006, constituting $326 billion of debt. After foreclosure and
resale, it is projected that about $112 billion will be lost to remaining equity, lenders and investors over several years. Since these losses represent less than one percent of the total mortgage lending
projected for that period, mortgage payment reset will not break the national economy or even the mortgage lending industry. However, the impact of reset-based foreclosure will not be spread
evenly, but will focus especially on teaser-rate (very low initial rates, often with interest-only and negative amortization features) and sub-prime mortgages originated in the past three years. These
loans will begin the reset process earlier than market-rate adjustable loans, and are more likely to default.

The study, which builds a color-coding arrangement to classify mortgages as yellow loans, red loans, and orange loans projects that:

• 32 percent of teaser loans will default due to reset
• 7 percent of market-rate adjustable loans will default due to reset
• 12 percent of sub-prime loans will default due to reset

The study also found that a small rise in prices will lift many properties out of equity difficulty and enable an escape from reset-based default through refinance or sale. Conversely, a small drop in prices will push many properties into equity difficulty and resulting reset-based default.

Regardless, many loans are being refinanced from adjustable-rate to fixed-rate terms, avoiding payment reset. In addition, many lenders are working with their clients to modify or refinance existing loans to avoid default.

The analysis, utilizing the extensive data and analytic resources of First American CoreLogic, examined 26 million mortgages, focusing on 8.37 million adjustable rate mortgages between 2004 and 2006 valued at 2.2 trillion dollars. The results are intended to provide the financial community and mortgage lending professionals with an extensive framework for assessing the default and foreclosure risk associated with loan products that involve mortgage payment resets.

About the Author
Dr. Christopher Cagan, director of research and analytics for First American CoreLogic, has more than a decade of experience in the areas of market research and competitive strategy for the real
estate and financial services sector. Since joining First American in 2002, he has developed several patent-pending mathematical and algorithmic inventions, built multiple analytical products, and
written numerous technical papers, presentations and studies. Dr. Cagan earned his bachelor’s, master’s and doctorate degrees in mathematics from the University of California at Los Angeles.