Increased Defaults as Interest-Only Loans Recast -Fitch


The ghosts of originations past could
still come back to haunt the housing industry according to a new report from
Fitch Ratings.  The company says that half
of those borrowers who have loans in performing residential mortgage backed securities
(RMBS) are facing increases in their mortgage payments over the next five

Fitch says the mortgages that will
be affected by increases are those with adjustable interest rates (ARMs), loans
that have had interest only payment features (IOs), and loans that were
modified to save or redeem them from default. 
Fitch notes that payment increases have historically led to high rates
of default with a correlation between the size of the payment increase and the
default rate.   

‘Interest-only loans are in store
for the largest payment increases,’ said Director Sean Nelson. ‘As a wave of
peak vintage 10-year IOs approaches recast, many mortgage borrowers could see
their monthly payments more than double.’

ARM payment increases are typically
tied to short-term interest rates so the magnitude of those increases are
expected to be smaller than for IO loans as long as rates continue at the
current pattern.  Modified loans
typically have scheduled and limited rate increases so borrowers should suffer
less payment shock. 

Fitch says the prime jumbo sector
has the most exposure to future payment increases due to a larger composition
of ARM and IO loans. Nearly two-thirds of performing prime jumbo loans are at
risk, whereas less than half of subprime loans are exposed to future payment

Any payment increases are expected
to have little impact on its ratings Fitch says.  Its US RMBS Loan Loss Model projects payment
increases and adjusts the probability of default accordingly. ‘While default
rates are expected to increase for loans with an upcoming payment hike, the
elevated default risk is already baked into our RMBS ratings,’ said Nelson.

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