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Does Another Wave of Foreclosures Loom?

Not likely, but you won't hear that from the media

Just as the media hyped the real estate bubble, reporters and pundits are now riding an alarmist wave of foreclosure news. Case in point: A recent newspaper headline warned, “Another Wave of Foreclosures Looms — Ballooning Payments Put Mortgages at Risk, Posing New Setback to Market.”

The concern at the heart of the article: An estimated 70% of Option ARMs will reset by 2011. Option ARMs are adjustable-rate mortgages that give the borrower choices regarding how much to pay each month.

At first glance, that statistic sounds scary — it represents $189 billion worth of loans. But is it really all that bad? Let’s find out.

There are 75.6 million owner-occupied homes in the U.S., according to the Census Bureau. Of those homeowners, 61% have a mortgage.

The article states that Option ARMs make up 1.3% of all mortgages. In other words, we’re talking about a little more than 600,000 mortgages. If 70% of those loans reset, the figure is about 422,000 mortgages. And don’t assume that those homeowners are going to default merely because their loans reset. “Reset” means the interest rate will adjust to new rates — and rates are now lower than they were three years ago when these loans were obtained, not higher. That means many of these homeowners might enjoy lower payments, not higher ones. Say half of the resetting loans prove unaffordable. Even that doesn’t mean the homeowners will necessarily default. Many, after all, will be able to figure out a way to keep making their payments.

But suppose half of them actually do go into default. In that case, we’re talking about 211,000 loans defaulting — spread over the next two years. That’s about 100,000 loans defaulting next year — out of 75.6 million homeowners.

That’s 0.14% of all homes. And that is supposed to support a headline that reads, “Another Wave of Foreclosures Looms — Ballooning Payments Put Mortgages at Risk, Posing New Setback to Market.” Either the writer of that article is deliberately attempting to scare readers needlessly, or the writer fails to understand the true nature of the situation. Incompetent or irresponsible? Either way, you shouldn’t draw incorrect conclusions from this story — and stories like this one are all too common.

-Article Written by Ric Edelman