Toxic For A Reason

Whole classes of mortgages are viewed as toxic for good reason:

For the third straight month, option adjustable-rate mortgages are generating proportionally more delinquencies and foreclosures than subprime mortgages.

Option ARMs were typically issued to creditworthy homeowners and allow borrowers to make a range of monthly payments. The payment options include a partial-interest payment that adds the unpaid interest to the loan's balance. On many such loans, balances have risen while values of the underlying properties have plummeted amid the housing crisis.

As of April, 36.9% of Pick-A-Pay loans were at least 60 days past due, while 19% were in foreclosure, according to data from First American CoreLogic, a unit of Santa Ana, Calif.-based First American Corp. In contrast, 33.9% of subprime loans were delinquent, with 14.5% of those loans in foreclosure, the figures show.

These loans are not only going bad in droves, but are producing massive, basically unprecedented losses when they do go bad. The average Alt-A or Subprime foreclosure results in the bank losing 64.7% of the original loan balance.

Put the numbers together and the underlying value of a given portfolio of option ARM and subprime loans is about 20%-25% less than the aggregate principal balance of the loans involved.

When the borrower has almost no equity, any decline in the value of the collateral mostly impacts the lender, and the value of real estate in the housing bubble markets where Alt-A and subprime loans were most common has plummeted.

So many loans are going bad in that in Sacramento, California, 70% of the homes on the market are being sold by lenders who have already foreclosed, or in short sales.