While the economy remains a shipwreck, many experts predict a second wave of the mortgage crisis involving Alt-A and Option ARM loans. But even more alarming is that some industry observers expect this new phase of the crisis to be worse than the original subprime fallout.

As the financial crisis spreads, and the housing market continues to limp along taking prices deeper into the basement, an entire new foreclosure tsunami is expected to hit in the next few months. A year ago, the word "subprime" reared its ugly head in the popular jargon of average Americans and was nominated by one literary club as the "word of the year." If things turn out the way many expert economists anticipate, the terms Alt-A and Option Arm may get added to that list of notorious mortgage industry expressions in 2009.

Trouble with Alt-A loans

Alt-A loans, which are mortgages that are one step up from subprimes in terms of their quality and resistance to problems, are failing in record numbers. That trend is likely to pick up steam going forward. These Alt-A loans are in many ways identical to subprimes, except for the fact that they're made to people who have relatively good credit. But plenty of people who had high credit scores two or three years ago are now in much worse shape because they've lost income, assets, and equity. They're slipping dangerously into the red, and as economic challenges expand, their ability to repay their Alt-A obligations will diminish.

Dangerous Option ARMs

Then there are the rather exotic loans known as Option ARMs, which are famous for giving homeowners more control of their payments. They're expected to tank in a big way, as ARM resets cause their rates of interest to spike, and make it much harder for homeowners to make their larger monthly payments. The Option ARM offers the choice of making payments of interest and principal, or smaller payments of interest only. Many homeowners have been making bare minimum payments, but that means that their principal hasn't shrunk. When the low teaser rates on those Option ARM products expire, automatic ARM resets may trigger a gigantic wave of foreclosures across the U.S., as homeowners find themselves owing much more than their homes are worth at a time when unemployment is leaving many Americans with no steady income. Typical payments will, for instance, go from $800 or $1,000 a month to $1,500 or $1,800 a month.

The perfect storm is brewing, in other words, but this time, it will pass through the heart of the real estate economy at a time when the nation is still trying to cope with the original disaster of the subprime crisis. Subprimes have cost our economy about a trillion dollars, and Alt-A loans may contribute another trillion in losses before 2010. Many will continue to reset into 2010, which means that the pain of foreclosures will be time-released and prolonged into the foreseeable future.

Published on January 20, 2009