A few weeks ago we stated here that we believe there will be more mid to upper priced foreclosures coming to the market in the next year, as more Alt-A mortgages are foreclosed on as scheduled interest rate resets take effect. We’ve seen most of the sub prime loans already come and go from the market. So the next wave should be the Alt-A and the economy driven foreclosures as regular people who have lost their jobs due to the falling economy begin to stop paying.

We based this upon a graph in our State of the Market Report published last January. You can view this graph in greater detail and in color on our Blog at http://ellis.realty-buzz.com or visit our Fan Page on Facebook at www.Facebook.com/Ellisteam As you can see by the chart, Option Arms are scheduled to reset at their highest point about August of 2010.

A feature of the Pay Option Arm is that borrowers are allowed to pick a payment, meaning they can pay any one of several payment options.  These loans began with low teaser rates, and one of the ways they allowed borrowers to minimize their payment was by allowing the buyer an option to make a payment less than the “Interest Only” portion of what the loan would have been.  These types of loans are called “Negative Amortization” because each month the borrower is losing equity.

Pay Option Arms were used primarily by borrowers who wanted to maximize their purchasing power by leveraging as much as the banks would lend with the absolute minimum payments.  These buyers didn’t worry that they were getting further behind each month as they figured the home would appreciate faster than the negative equity would accrue due to the loan.  Most of these borrowers planned to “flip” the property and make a fortune, then repeat the cycle all over again.

In this cycle of irrational exuberance, few thought about when the musical chairs would run out.  It seemed like that crazy market would last forever, until one day when the music died.  You could see the train wreck that would one day ensue.

Simultaneously, the value of the property is in free-fall and the loan amount is increasing by the month.  You’ve heard the terms “Upside Down” and “Getting Hit at Both Ends”.  This pretty much sums up what happened to Option Arm borrowers in heavily concentrated investment areas like many new subdivisions here in SW Florida.

Have you ever wondered why certain established neighborhoods held their value fairly well through the downturn, while newer communities seemed to take it on the chin?  The answer is investors and speculators flocked to newer construction, as this is where the perceived pre-construction deals were back in 2003-2005.  The problem is we had too many speculators.  Investors can be quite healthy for a market, but a speculator just drives up prices for the sole purpose of Flipping to another buyer.  The only useful purpose this would serve is providing the capital to speed up construction to provide much needed supply due to high levels of demand.  The problem is, we had phantom demand.  Our market sped up the supply side without real end users.  There’s something not quite right when the end user is another speculator buying to flip same property for a 3rd or 4th time to another speculator.  Eventually the music dies and the musical chairs run out, except this is real life and not fun and games.

The rest of us have been picking up the pieces from this sad game, and we’ve all paid a price.  Construction jobs have left, values have plunged, banks have failed, taxpayers have paid for a bailout, and just about everyone that played the game is sorry.

Many of these Option Arm’s have already defaulted as the speculators learned early on they couldn’t flip the property for a profit, so they quit making payments.  We do believe there are some regular buyers who also used the Option Arms to purchase more home, and some have been hanging on for as long as they can because they can’t afford to sell their home.  Once these payments reset, we could see another round of foreclosures hit the market.  These buyers tended to buy the mid and upper tier homes.  This is one reason we predict you’ll see more higher priced homes coming out of the foreclosure pipeline.

We’ve seen the foreclosure pipeline growing in the past few months, and due to processing delays, we expect several foreclosures to start hitting the market this month.  Filings are down, so the foreclosures coming out now were backlogged from back in December and January.  The resets in 2010 and 2011 will also take awhile to work their way through the system, so bottom line is we’ll see a certain amount of foreclosures for the next several years.  The sooner we clean them up and ship them out the sooner we’ll be on our way to a normal market, so I say bring them on without delays, so we can all get back to listening to the music.  Leave your chairs at home.