Q&A: Ask a broker

Q: What's the difference between "resetting" and "recasting."

A: Let's say that you have an adjustable-rate mortgage where the payment is changed annually. The index used to set the rate has gone up so at the end of the year the monthly payment will be adjusted -- that's a resetting.

Recasting is different. Typically ARMs are recast every five years, meaning that the payment is adjusted so that at current rates the loan will be paid off by the end of the loan term, say the remaining 25 or 20 years. The annual payment cap, usually 7.5 percent, does not apply when a loan is recast.

There is also another type of recasting. When monthly ARM payments are not sufficient to pay even the monthly interest cost, any unpaid interest is added to the mortgage balance. This is a process called negative amortization.

The catch is that ARMs agreement say that if the outstanding loan balance reaches a certain point, say 110 percent or 115 percent of the original mortgage amount, then the loan must be immediately recast.

Example: Someone has an "option ARM" and only makes the minimum monthly payment. Each month the debt increases. According to a September study by Fitch Ratings, "the potential average payment increase on this recasting population is 63%, representing on average an additional $1,053 due each month on top of the current average payment of $1,672." (See: "Option ARMs, It's Later Than It Seems")

Why is the payment increase so steep with option ARM recasting? Three reasons. First, the loan term is no longer 30 years, it's now something less. Second, the loan amount is at least 10 percent larger than the original debt. Third, the new interest rate may be significantly higher than the starter rate.

How quickly can option ARMs be recast? According to Fitch, a borrower with a 40-year option ARM who makes only minimum payments can face recasting in as little as 28 months.

What do we call an option-ARM borrower with a loan that quickly recasts? In too many cases, the answer is: foreclosed.

Q: We keep hearing about lenders who are now in trouble because of toxic mortgages. Didn't these lenders have insurance? What's happened to the mortgage insurance companies, the firms that provided such coverage?

A: In the usual case private mortgage insurance is required when borrowers purchase homes with less than 20 percent down. Figures from the Mortgage Insurance Companies of America, the industry trade group, show that mortgage insurers had operating profits of roughly $2.2 billion in 2005 and 2006 -- but operating losses of $1.45 billion in 2007.

While the 2007 losses were significant, and while additional losses are likely, the industry also has substantial assets. In 2007 the MI industry reported that it had "admitted assets" of $22 billion, $6 billion in loss reserves, $11.1 billion in contingency reserves and $595 million in unearned reserve premiums. As of July the industry had in force policies worth more than $800 billion. ("Admitted assets" are assets that regulators allow insurance companies to count when calculating their worth. The definition for "admitted assets" is more restrictive than the meaning of "assets" under general accounting rules, according to MICA spokesman Jeff Lubar.)

While the MI industry has been paying claims, toxic mortgages are often uninsured by such companies. For instance, many borrowers purchased real estate with "piggy-back" financing to avoid mortgage insurance costs. In such arrangements there is a first loan equal to 75 percent or 80 percent of the purchase price and a second loan for some or all of the rest. Since the first loan is less than 80 percent of the purchase price no mortgage insurance is required. Of course, where there is no insurance there is no insurance coverage for lenders if borrowers stop paying.

Q: When will our local market return to normal?

A: The market cannot return to a place it's never been.

There is no such thing as a "normal" long-term, real-estate market. There may be averages, there may be memories of good times and bad, but markets are always in flux.

In July 2008, the typical existing home sold for $212,400 according to the National Association of Realtors. Is that a lot or a little? Is that normal? A year earlier that same house sold for $228,600.

What will the typical house sell for in a year or two? No one knows, but at the time of the sale you can bet that the price of the moment will be "normal" -- at least until the next transaction.