Thursday, June 16, 2005

Jason: Z, what the hell do you do for a living? Z: Well, I look at mortgages and... Jason: Zzzzzzzzzzzz...

I've posted about cockfights, and I've posted about poo. I feel a need to balance that with something a little more serious (and boring to 99.9% of people out there). So here we go.

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Here is the cover story of today's NY Times Business section. It talks about the mortgage market these days and the looming wave of payment shock that many borrowers out there will be facing in the coming years. Why does anyone care? I guess in one sense people care because if this gets out of hand it might, uh, affect the economy or something. Realistically, the only reason anyone reading this would care is that it gives a better idea of what the hell I am doing when I stay late at work. (Trying to find an answer to the questions raised in the article. I have some answers already, but they are proprietary to my company and I'd have to kill you and repossess your belongings if I told you)

Everyone is making a huge deal about the volume of interest only and neg am loans out there. I actually don't think it's as much of an issue as they believe. Only the borrowers stupid enough to take out an IO because "then you get to pay less each month" will become real problems. The majority of people out there are (hopefully) using the IO to simply manage cash flow over the course of the year a bit. Assuming that is true, the mortgage market will not implode. If I am wrong, well, then I'll just have to work even later while trying to find some way to cover my ass.


At 6/17/2005 10:25 AM, Blogger Michael said...


Just kidding, good post.

At 6/17/2005 11:38 AM, Blogger Brian said...

what's a neg am?

At 6/17/2005 12:37 PM, Blogger Z said...

Allow me to give a short class about the mortgage market.

With a 30 year fixed rate loan, you will pay the same amount every month (or more), and in 30 years (or less) you will have paid off your mortgage because each payment covers a portion for interest and a portion for principal.

With a 30 year adjustable rate loan, you will pay a different amount every month. Exactly how much depends on what happens with interest rates - if rates go down you required payments go down as well. This loan exposes you to interest rate risk (rates could rise), and as a result the incentive provided to the borrower to take out an adjustable rate loan is your comparable rate vs. a fixed rate loan will be lower. For example: Right now you could get a fixed rate loan for ~5.5%. if you wanted to go with a purely adjustable rate loan maybe you could get it for ~4% (starting rate...of course that rate floats over time).

There are hybrid loans that are fixed for a certain period of time and then convert to floating. The shorter the fixed period, the lower the fixed rate you will receive as "compensation" for you assuming that interest rate risk later on. So a 10/1 (fixed for 10yrs, floating after that) might have an initial rate of ~5.2%, whereas a 3/1 will have an initial rate of ~4.2%.

Then we get to neg am loans (neg am stands for negative amortization), also known as option ARMs. These loans are floating rate loans, but with a twist. They are a relatively new invention in the mortgage world. They are called option ARMs because you typically have one of a few different payment options.

You will start out with a "teaser rate" for three months (pretend it's 1%), off of which your monthly payment is determined for a 12 month period. Let's say that payment is $100. After the teaser period is over, your rate floats on a monthly basis...but your required payment does not. So every month the borrower will receive something in the mail that lets them make one of three payments.

1) the fully amortizing payment: since your rate has gone up (no longer 1%), your fully amortizing payment has as well. Now it might be $500.
2) the interest only payment: same as above, but you don't pay down principal at all, just interest. Hence the name. This might be $450. Next month your balance will be the same as last month since you haven't paid down principal
3) the "minimum" payment: you make your original $100 payment. This does not cover all the interest or any principal. You are still considered current on the loan, but the difference between what you paid and what was "needed" is rolled into your balance. If you mortgage was for $100,000, your new balance would now be $100,400. [You paid 100 of the 500 required to amortize].

On the surface this seems like a phenomenally dangerous thing. I won't get into specifics, but there are clauses placed in the loan that limit how high your balance can really go, and that also require you to amortize fully at the 5 year you can't just neg am forever.

40% of all jumbo loan origination this year has been Neg Am product. That's a lot.

See what happens when Jason leaves? I turn his blog into nerd central and start boring everyone. :)

At 6/17/2005 2:56 PM, Blogger Brian said...

zzzzz.... :snor: huh?

j/k thanks for the lesson.

At 6/17/2005 3:40 PM, Anonymous Big Daddy Rinke said...

You guys are more boring than Jason......what happened to the funny and interesting posts?
Jason is gonna kick all of your asses!
And by the way Raz, can you get me a good loan rate?

At 6/17/2005 4:45 PM, Blogger Michael said...

Everyone who isn't mousing over Rinke's name should be, I eagerly await each new post. Those who don't know what mousing over means...well, too bad so sad.

As for the content being put up, I think its great, at any rate far more interesting than the crap I put up on my blog. I'm totally making all of you put stuff up on DWS when I take vacation...if I take vaction...ever...

At 6/20/2005 9:53 AM, Blogger Z said...

This comment has been removed by a blog administrator.

At 6/20/2005 7:01 PM, Blogger Z said...

I can't get you a good rate, as I am not a broker my any means. I work for the guys who buy your loan and if you default then my company loses money and I get a lower bonus and take the difference out of your ass next time we go skiing. But...if you (or anyone for that matter) are thinking of buying a house, I can talk your ear off about the different mortgage options available to you.


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