Mortgage Opportunities Knocking for ARM Companies

There are strong indications that mortgage delinquencies will increase significantly in the near future. As this occurs, some accounts receivable management companies – especially those servicing mortgage lenders – are well-positioned to benefit from this trend.

Traditionally, most homes were purchased using fixed rate mortgages where borrowers lock into an interest rate over a definite period of time. Over the past five years, however, an alarming number of borrowers have utilized adjustable rate mortgages known as interest-only and option mortgages to finance their home purchases.

The lure is that these loans have lower monthly payments initially compared to fixed-rate loans. In regions across the United States where housing prices are relatively high, the use of adjustable rate mortgages has enabled many buyers to purchase homes that are way beyond their means.

The risk to the borrower is that at a future point, the monthly payments will increase two-fold or more to cover the deferred interest and principal amounts that were not paid initially. When the rate adjusts and monthly payment amounts increase significantly, these homeowners find themselves stretched thin financially. Some owners are already starting to struggle to make their monthly payments.

Borrowers with these nontraditional types of mortgages are most vulnerable because they could wind up losing their homes to foreclosure if they cannot afford to make the increased payment; or, if prices start to come down, they could wind up owing more than their home is worth in the marketplace.

This is already starting to occur. From 2004 to 2005, the number of borrowers that owe more than their house is worth has nearly tripled – from approximately 10% of those who took out loans in 2004, compared to nearly 30% in 2005, according to a study completed by Christopher L. Cagan, Director of the research and analytics firm First American Real Estate Solutions. Some fear that this is only the tip of the iceberg. According to the Washington Post, about two thirds of all people who bought homes in the Washington DC area in 2005 used interest-only or option mortgages.

Earlier this year, John M. Reich, director of the Office of Thrift Supervision, voiced concern that if housing values fall, borrowers who have taken on risky nontraditional adjustable rate mortgages could face foreclosure, leading to financial losses for the lenders who made such loans. Some regulators, likening the real estate market to the savings and loan fallout of the early 1990s, have been warning lenders that they will restrict the use of nontraditional loans. To date, regulators have only offered guidelines to federally chartered banks and credit unions to make certain that loan applicants truly understand the loan’s mechanics. It hasn’t yet reached down to state regulated mortgage brokers and independent mortgage companies.

By the time restrictions are firmly in place the damage may be too severe. With more adjustable rate mortgages in the market now than ever before, the rate at which mortgage payments are becoming delinquent is increasing. Mortgage delinquencies historically peaked around three years after the loans were made. With adjustable rate mortgages, delinquencies most likely will occur a lot sooner.

This could be the making of a “perfect storm” for collection agencies and debt buyers already servicing financial institutions that provide mortgage loans. Many of these credit grantors have experienced the benefits of outsourcing their collection needs, or selling debt, to third party professionals. As mortgage delinquencies increase, these collection agencies and debt buyers are well positioned to see more business as a result of this trend.

Many borrowers are on the verge of financial crisis – making minimal monthly payments on their credit cards and juggling other obligations just to make ends meet. Borrowers are always making choices about which delinquent accounts they should pay and which ones they should put off. When their adjustable rate mortgages come due – unexpectedly increasing their monthly debt loads – the fear of losing their home to foreclosure will be enough of a reason to convince most homeowners to put their delinquent mortgage payment on the top of their list of bills to pay, ahead of credit cards and healthcare bills. Collectors are always trying to convince debtors that their accounts should be paid first. Now the convincing will be done for them.

I realize that mortgage delinquencies are still relatively low by historical standards. However, with the housing market showing signs of cooling off, and more adjustable rate mortgages in the market than ever before, we are already beginning to see increases in delinquency rates for mortgages. For the accounts receivable management companies that service mortgage lenders, now is a good time to prepare for what’s coming.

Mike Ginsberg is President and CEO of Kaulkin Ginsberg Company, which, since 1989, has provided owners, investors and executives with the advice, expertise and information needed to grow or sell their companies. Kaulkin Ginsberg is the most recognized source of M&A, research and consulting services for the Debt Collection and Accounts Receivable Management industries. The Kaulkin Media division publishes the leading credit and collections website, insideARM.com, as well as several popular electronic newsletters.

Mike has served as chair and keynote speaker at numerous association meetings and industry conventions. He is a member of the board of the Institute of Merger and Acquisition Professionals (IMAP), a member of the Association for Corporate Growth (ACG), and a member of the American Collectors Association (ACA) and Debt Buyer’s Association (DBA). He also serves as an expert witness, and sits on the advisory boards of several industry associations and publications. Mike can be reached at (301) 907-0840 or at mike@kaulkin.com.