Sector-Specific Trends Impacting Credit Card ARM: Mortgage

Just as breathless as the calls of instant riches in the real estate boom of the early 2000s have been the calls of doom and disaster when it turned out a bunch of people who shouldn’t have bought houses did with the lure of easy credit and scant savings.

For at least two years, the usual panoply of naysayers – media economists, consumer advocates, and bank critics – have foretold the imminent demise of the American economy by way of mortgage defaults.  Folks will lose their homes, banks will struggle under the weight of charge-offs, and blood will generally flow in the streets.  And to their credit, some of that has happened.  A number of subprime mortgage lenders have gone out of business, large mainstream banks are experiencing earnings erosion, and homeowners are losing their homes in numbers greater than historically average.

The general consensus is that adjustable rate mortgages -- loans that offer attractive initial rates that increase after a short time – and “exotic” mortgages, such as interest-only loans, are the main culprits.  Folks that in no way were able to afford a home were enabled by lenders’ willingness to stretch out to an underserved and untapped market.  But when interest rates began to readjust after the initial period (typically 1, 3, or 5 years) and/or homeowners began to pay principle rather than just interest, the occurrence of delinquency increased.  Add on the fact that many borrowers bought homes with no down payment, thus necessitating a second mortgage or home equity line of credit to cover the traditional 20 percent down payment.  So many homeowners were left making not just one mortgage a month, but two.  And often, the actual payment on the second mortgage was not just a mere 20 percent of the main mortgage payment.  When lenders approved 100 percent financing, the second mortgage, or line of credit, typically carried a much larger interest rate, driving the monthly payment up to 25-35 percent of the primary mortgage payment.  Then, of course, there are other monthly payments unique to homeownership: larger utility bills, property tax, insurance, and maintenance.

Simply put, many homeowners found themselves stretched very thin just by agreeing to purchase a home.  So naturally, some other debt obligations that were previously front-of-mind were relegated to back-burner status; more pointedly, credit card delinquencies have been on the increase.

According to the Mortgage Bankers Association, delinquencies on mortgages for single-family homes – specifically defined as “one-to-four-unit residential properties” -- stood at 4.95 percent in the fourth quarter of 2006, the latest period for which data is available.  This number comes from MBA’s National Delinquency Survey, a fairly comprehensive survey that covers 43.5 million total home loans.  MBA breaks down that loan total as: 33.3 million prime loans, 6 million subprime loans and 4 million government (FHA and VA) loans.  Q4 2006’s total delinquency number reflects an increase in delinquencies across all loan types, however.  Not even prime loans are immune to the recent surge in late payments.  In fact, drilling down into MBA’s numbers yields some fascinating results.

In the last quarter of 2006, 2.57 percent of prime loans were delinquent, compared to 2.44 percent in the previous quarter.  The delinquency rate for subprime loans was a shocking 13.33 percent, up from 12.56 percent.  And specifically, subprime adjustable rate mortgage had a 14.44 percent delinquency rate, the highest overall delinquency rate for any segment, and the largest increase of any segment (in Q3, the rate was 13.22 percent).

So subprime mortgages, and specifically subprime adjustable mortgages, are going delinquent in large numbers.  How does that affect credit card payments, though?

According to the American Bankers Association, the credit card delinquency rate stood at 4.56 percent in the fourth quarter, holding steady – actually, improving slightly – from the third quarter’s figure of 4.57 percent.  But while there has been some recent slight improvement in credit card delinquencies, the numbers are still at near-record levels.  According to the ABA, the second quarter of 2005 saw the highest rate of credit card delinquencies since the organization began tracking the statistic in 1972.  That rate stood at 4.81 percent.  But the ABA claims that gas prices, more than any other input, are to blame for the rise and fall of credit card delinquencies.

The Federal Reserve has the largest repository of statistical information on consumer credit in the country.  They track all kinds of metrics dealing with credit in the U.S., including credit card delinquencies and charge-off rates at commercial banks.  According to their numbers, home loan delinquencies are trending upward, as are credit card delinquencies.  But as with the ABA’s numbers, there is not a hard correlation between mortgage delinquencies and credit card delinquencies, and more to the point, credit card charge-off rates.

But how do total delinquencies at the bank level correlate to the contingency ARM market?  Remember, no matter how the actual rate fluctuates, the total outstanding totals for credit card debt increase on a monthly basis.  So even if the delinquency and charge-off rates of credit card debt fall slightly in a given quarter, the total pie from which those totals come is growing, which naturally translates to more total accounts and dollars charged-off, regardless of the rate.

The more immediate threat the current mortgage mini-crisis poses to credit card collectors could be in the form of willingness to pay once the debt has been assigned to contingency collectors or sold to debt purchasers.  Last week, Fed Chairman Ben Bernanke told bankers that he did not believe mortgage defaults and foreclosures would drag down the overall economy, and he vowed that a crackdown was coming on predatory mortgage lending.  Reassuring words, to be sure.  But he also cautioned that mortgage delinquencies and foreclosures would increase significantly over the rest of this year and into 2008.  If that is the case, debtors could increasingly find themselves without the ability to pay third-party debt collectors looking to recover credit card debt.  Also more importantly, even with the new stricter bankruptcy laws in place, many consumers could opt for the bankruptcy option in increasing numbers over the next couple of years.