Opportunities for Foreclosure Specialists on the Rise 

When ARMs adjust, many homeowners can't afford the new payments

By Jordan Taylor

As housing prices escalated over the past few years, lenders developed a variety of creative loan products to help borrowers buy their dream homes. But those dreams are getting ready to turn into nightmares for homeowners with adjustable rate mortgages (ARMs) who are soon going to be dealing with higher monthly payments that they can't afford.

"No-down-payment loans, interest-only mortgages, and adjustable rate mortgages-particularly three-year ARMs-became very popular as housing prices surged and lenders developed creative ways to get buyers approved for the homes they wanted," says Gina Bowles, lead foreclosure instructor for Wealth Intelligence AcademyT. "In 2006 and 2007, we're going to see many of those three-year ARMs adjusting to current interest rates, and many homeowners will not be able to manage the higher payments." That will mean tremendous opportunities for savvy investors; however, to help homeowners who are facing skyrocketing monthly mortgage payments, you need to first understand how the loans work and the circumstances they create.

Bowles offers this example: A buyer purchases a $250,000 home with a three-year one-percent ARM. The monthly payment for the first three years is approximately $800-an amount the buyer could qualify for. But when the loan adjusts to, say, a seven percent rate, the payment jumps to more than $1,660. "Many Americans are living paycheck-to-paycheck and they just can't handle their mortgage payments suddenly doubling," says Bowles. "They will try, but a substantial portion of homeowners with this type of loan are going to be facing foreclosure, and are candidates for the assistance a trained foreclosure investment specialist can offer."

In addition to the traditional ARM which starts with a low interest for a fixed period (typically one, three and five years, although some lenders are offering seven- and ten-year ARMs) and then adjusts annually, lenders are also offering an "option ARM." This product allows borrowers to choose from three different payment plans each month: they can make a regular principal and interest payment, an interest-only payment, or a smaller payment that doesn't cover the interest. With the latter option, the total amount owed will increase. Homeowners with option ARMs can change the amount they pay every month, depending on their specific situation and budget. The downside is that they are at risk of owing more on their homes than they originally borrowed after several years.

Virtually all lenders now also have an interest-only mortgage product, which means that for a designated period (usually five to ten years), borrowers pay only the interest portion of their monthly payment. At the end of the interest-only period, the loan reverts to its original terms and the payments are adjusted upward to reflect full amortization over the remaining years of the loan. Interest-only mortgages are not new; they were very common in the 1920s, but lenders stopped writing this type of loan after the rash of foreclosures caused by the Depression of the 1930s. Interest-only loans have regained popularity as a technique that allows people to manage their cash flow and-in theory, anyway-make better financial decisions. Unfortunately, many people are using these loans to buy homes that would be out of their range with traditional financing.

According to the Mortgage Bankers Association, an estimated $330 billion worth of ARMs will adjust upward in 2006 and $1 trillion worth will adjust by the end of 2007. This means more than 3 million homeowners are going to be facing bigger mortgage payments in the next two years. Moreover, many of those loans were made to marginal buyers, including lower-income individuals and people with a history of credit problems.

Some homeowners are choosing to refinance into a fixed-rate traditional mortgage, but others may not be able to qualify. In many cases, it will just come down to the fact that people used creative financing to buy more house than they could afford, and they're going to find themselves in deep financial trouble.

"As the rates on the ARMs adjust and the interest-only mortgages revert to their original terms, we expect the number of foreclosures in the United States to rise," says Bowles. "The opportunities for investing in foreclosures and pre-foreclosures are going to be tremendous across the country. Investors who understand what is happening and know how to deal with these situations will be able to help these borrowers and make a substantial profit for themselves in the process."