Housing Again?

A new wave of housing defaults is in the offing according to this article in the New York Times.

Experts predict a steady drumbeat of defaults over much of the next decade as these interest-only loans mature. Auctioned off at low prices, those foreclosed houses could help brake any revival in home prices.

Interest-only loans are not the only type of exotic mortgage hanging over the housing market. Another big problem is homeowners with “pay option” loans; in many of these loans, principal balances are actually increasing over time.

Still, interest-only loans represent an especially large problem. An analysis for The New York Times by the real estate information company First American CoreLogic shows there are 2.8 million active interest-only home loans worth a combined total of $908 billion.

The interest-only periods, which put off the principal payments for five, seven or 10 years, are now beginning to expire. In the next 12 months, $71 billion of interest-only loans will reset. The year after, another $100 billion will reset. After mid-2011, another $400 billion will reset.

In a sense people with interest-only loans were really renters. They had no real equity in their homes. They were renting with an option to buy if the appreciation of home prices made their gamble pay off. But with housing prices tanking the option is no longer in the money. The problem for such people is that with the option out of the money their rent goes way up. Normally, if the rent is raised dramatically a household can move. But these people are locked in to a much greater extent, at least to the worth of their credit reputation, which will be destroyed when they default.

I guess the unknown here is how large the impact of these defaults will be on the economy as a whole. Presumably most of the shocks to the financial system have already been taken. All securitizations in the housing sector have taken hits. The major impact would be on a recovery in home prices.