Home » Foreclosure Resource Center » Are Fixed-Rate Loans About To Vanish
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The Shifting Market For the past 18 months, there have been almost daily reports of investors fleeing from subprime and Alt-A loans — the mortgages with the most defaults and the greatest level of risk. Investors have also begun to back away from prime loans and with some reason: Even they are not as sure or certain as expected. As Jaime Dimon, chairman and chief executive officer at JPMorgan Chase just told analysts, “prime looks terrible.” From an investor’s point of view, the default rate for prime loans is not quite what it seems. Yes, bigger losses are a problem, but there are other concerns as well. A large and growing portion of the American economy is financed by overseas dollars. If you’re an investor and live outside the U.S. then you have a number of ways to make money with American assets. Imagine if you buy prime mortgage-backed securities worth $75 million that pay 5 percent interest. If you expect .5 percent of the loans to fail — loans worth $375,000 — you will still earn your 5 percent. But if fully 1 percent of the loans fail — mortgages worth $750,000 — you won’t earn 5 percent because you now have an additional $375,000 in losses. That’s a problem, but perhaps not a terrible problem. Remember, the value of your investment is measured in dollars so in a sense your mortgage-backed security is a commodity of sorts. If you have a $75 million asset and the value of dollars increases by 10 percent against your currency then you've made $7.5 million because now your dollars buy more. But what if dollar values fall? If the value of the dollar drops 10 percent your spending power has been reduced by $7,500,000. Add in $750,000 in foreclosed loans and you’re out $8,500,000. Ouch! There is, however, still another way to protect your investment. Instead of fixed-rate mortgages, you could make sure that some or all of the loans in your package are adjustable. As inflation increases and the value of the dollar drops, interest rates would automatically rise as indexes go up. In effect, ARMs are a lender hedge against inflation and devaluation. For example, if the overall interest rate on your loans went from 5 percent to 6 percent, you would gain an additional $750,000 each year. Not only would your interest income go up, if loss rates remained at expected levels the value of your security would also increase. A $75 million security that pays 5 percent produces income worth $3,750,000 a year. A security that produces $4,500,000 is worth $90,000,000 for investors looking for a 5 percent return. |
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