As you can see, 2006 and 2007 will be peak years in terms of subprime and jumbo loans. Given that many of these loans have prepayment penalties many folks will not be able to refinance given the limitation inherent in the loans. The reason we have not seen the impact of the current ARM resets is that the real estate market has been hot. So hot in fact that even with a prepayment penalty many were able to cash out or even sell homes before facing the piper. This circular system keeps working until appreciation stops. Not only that, rates are much higher than they were in 2004. Keep in mind that most ARMs and interest only loans are pegged to short-term rates such as the LIBOR. Basically they go in tandem with the feds short-term rates.
This is important because another argument you will hear is the fact that the 30 year rate is trending down. Now, this is another important issue to consider. Why would 70 percent of California use interest only, ARMs, or option only mortgagees this last year if rates were so attractive? Because they cannot afford the homes! This party is now over as is demonstrated by the massive decrease via our canary in the mine, San Diego:
The drop is 4.5 percent year over year and DOUBLE of the 2.2 percent loss we had in August of 2006. Leverage is a beautiful thing, like looking at a reddish sunset over the desert. When things are going good, you can get wealthy very quick. When things go down however, leverage works just as fast in the opposite direction. By looking at the above chart, we have yet to see what will happen when appreciation takes a quick exit on the 405 to depreciation, inventory numbers explode, and rate resets happen to many unsuspecting homeowners. I believe many of these homeowners assume they’ll be able to sell their home believing 20 percent year over year increase are cemented into the equation. Even if the market stays flat, where will they come up with the average 6 percent commission to market and sell the home? This question will be answered next year and hopefully it’ll only cost one ARM and no leg.