Just as defaults on sub-prime loans are showing signs of diminishing, a new wave of lending problems may be about to hit. Defaults by homeowners with good credit are on the rise.
Many of these borrowers have interest only loans, commonly referred to as "option ARM" loans. When these loans adjust, the borrower is required to make payments that includes interest plus principal. Unlike sub-prime loans, which typically adjusted upwards after two or three years, these option ARM loans usually had a five to seven year period before the borrower was required to pay both principal and interest. For many, that grace period is now coming to an end.
Even if a borrower's interest rate remains unchanged, the additional principal payment (on top of the interest payment) could mean an increase of 50% in the monthly payment. Because lending requirements have tightened and home values have declined, these borrowers can not refinance their loans. And with property values down, some homeowners can not sell at a price that will cover the loan amount.
Lenders are starting to see defaults on these loans, and there is concern in that as these option ARMs adjust, a new flood of delinquencies will hit the banking industry.
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