Record High Foreclosures and Option ARM Resets

With headlines of higher default rates for Option ARMs about to be a daily occurrence, is there a way to profit from others’ misfortunes?

Yep…

But let’s first look at the size of the crisis… and why the crisis is far from over.

To say the end to our woes is in sight is as premature as saying terrorism is under control.

Unemployment will continue to climb. Consumer spending will suffer. And housing is only expected to worsen, as more resets rear their ugly heads.

Sure, construction of new homes (helped by good weather) rebounded in November. And sure, the gain is a hopeful sign of a housing recovery. And yeah, sales have surged in recent months, as home buyers scrambled to take advantage of the first time home buyer tax credit…

But there’s only one problem with the bullishness: It’s overdone.

There is no recovery. The crash is far from over. Even Moody’s doesn’t see an end to the housing meltdown, believing that home prices will soon start moving back down because of coming foreclosures.

Another obstacle for the housing recovery is the number of mortgages that are underwater where borrowers owe more than what the house is worth. This negative equity doesn’t qualify those people for refinancing and even prevents them from selling the home, often resulting in “strategic defaults.”

But the most devastating of all could be the coming Option ARM (adjustable rate mortgage) resets of 2010 and beyond. It could easily lead to higher unemployment, housing glut, decreased home values, and the death of the cash-strapped consumer.

What do you think will happen to housing when the resets happen? What do you think will happen when monthly payments on a $400,000 mortgage jumps from $1,287 to $2,593?

This is reality. And savvy investors will play it smartly.

Sure, you can short housing names and housing-related retailers… but everyone knows about those. You have to invest where the sheep haven’t been.

You have to invest in the very stocks that benefit as foreclosures worsen… you have to buy the companies that help when foreclosures mount… and you have to do it fast, as the sheep catch on.

Here’s why…

The Year of Option ARM Resets. . . and Why There’s No Foreseeable Bottom

About a year after the Obama Administration unveiled the housing rescue program, foreclosures continue to hit new records. More than 2.8 million properties were foreclosed upon in 2009, up some 21% from 2008 and up more than 120% from 2007, according to RealtyTrac.

And another three million could foreclosure this year alone.

And they find themselves in foreclosure because:

• They couldn’t afford the properties they bought;
• Jobs were lost… and is only expected to worsen;
• And others are just walking away because “it’s not best for their finances… “

These “walk aways” or “strategic defaults” have more than doubled from 588,000 from 2007 to 2008, according to reports.

And there will be more, as financial “experts” tout the benefits of walking away from mortgages.

Does that sound like a recovery in process to you?

Unfortunately, just as 2007 and 2008 were the years of subprime woes, this one will go down as the year of Option ARM resets. With billions in Option ARM resets in 2009 and 2010, this crisis is about to unleash a fury no one’s prepared for.

It won’t be as bad as subprime, of course. It’ll be worse.

That’s because lenders created these ARMs with “teaser” features for borrowers, which included making lower minimal payments for the first few years before the loan reset to a higher payment schedule.

And if that weren’t bad enough, there was another feature called “negative amortization,” which meant you weren’t paying back any principal.

In fact, with negative amortization loans your loan balance increased over time. Incredulously, every time you made a payment, you owed the bank even more. These are the loans that allowed consumers to buy houses they couldn’t otherwise afford.

As for speculators, they may use negative amortization loans if they believe prices will increase at a fast pace. But with the opposite happening, they’re out of luck.

And the banks will be left holding the bag.

Big banks and mortgage services face a huge increase in mortgage delinquencies this year. And the government’s program to modify troubled home loans is “ill-equipped to handle even the current volume of modifications,” say reports.

At issue are the Alt-A and Option ARMs that became wildly popular before the financial crisis. You see, as the subprime market surged to $1 trillion, the Alt-A and Option ARM markets far exceed $1.5 trillion… meaning the ARM crisis is far worse than subprime.

But as we’ve said, there is a very easy way to profit as the foreclosure crisis worsens… you buy and hold the companies that process foreclosures and make a killing as it happens.

And we’ve got two companies will profit from the rampant increase in foreclosures and defaults.

Unfortunately, if we mention there names here, we run the risk of running the two stocks to the moon… something we really don’t want to do. So, we’ve prepared a special report for Options Trading Pit readers that unveils the stock names, and how to play them with options, as well.

But you’ve got to hurry. One of the options is already up some 40% in about a week.. and we only expect further growth from mounting foreclosures. For more on Options Trading Pit… and to get your hands on our latest special report, click here.

And as for the housing bulls… well, they’ll learn the hard way.