This article originally appeared on RealMoney.com on Sept. 3, 2014 at 4:00 p.m. To read more content like this AND see inside Jim Cramer's multi-million dollar portfolio for FREE... Click Here NOW.
Another round of legacy issues in the mortgage industry will soon confront the housing and banking sectors. Adjustable rate first and second loans (most with 10-year resets) that were a large percentage of the loans originated at the height of the housing mania are now approaching their reset dates. The largest concentration of these was for properties financed with jumbo first-trust loans, which means they are mostly on higher-priced properties.
Let's look at the second-trust issue. There are two kinds of second-trust residential mortgages: open-ended and closed-ended.
An open-ended second-trust loan is typically a line of credit with a 30-year amortization and an ability to draw against the line of credit for the first 10 years. During that time, the mortgagor pays interest only at the accrued rate on the portion that's been drawn. At the end of 10 years, the remaining balance is converted to a fully amortizing loan over the remaining 20 years.
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A closed-ended second-trust loan is a fully amortizing fixed-rate loan with a period of 10, 15, 20 or 30 years, although some have 10-year balloons.
The current issue facing the mortgage and housing industries are the open-ended second-trusts that were originated as purchase-money loans in which the entire line of credit was pulled at the closing of the home purchase. There are currently about $500 billion worth of open-ended second-trusts within the U.S. banking system compared with only about $80 billion that are closed-ended. To put that in context, there is about $675 billion of credit card debt and $1.75 trillion of first-trust loans. Credit cards and first-trusts don't have resets after 10 years that send payments up, though. The open-ended second-trusts are a big deal.