Mountain of Sub-Prime Mortgages Primed for Avalanche
(2.2 million households could face losing their homes)

Where the Sub-Prime Market is Headed

The alarm bells are ringing now as the housing boom is over in most states and is starting to reverse course in others.  The rate of foreclosures began to accelerate in 2005 and in 2006 hit 1.2 million in foreclose filings, up some 42% from the prior year.  This amounts to a shocking ratio of 1 mortgage foreclosure for every 92 households and could be just the tip of the iceberg, as foreclosures in the month of December of 2006 were up 35% from December of 2005.  Some states are now reporting as much as a stunning 700% increase in foreclosure filings in 2006 over 2005 and it is estimated that as many as 2.2 million households could face losing their homes in the not too distant future.  It is predicted that over the next 6 years, of the 8.4 million adjustable rate loans originated between 2004 and 2006, some 13% to 20% will go into default.

A key predictor of a borrower's likelihood to default on their mortgage payment is the amount of equity a borrower has in their home.  Late in the housing boom as the prevalence of 100% financing, option ARMS and interest only loans increased, these borrowers who put little or nothing down to purchase a home could quickly find themselves with negative equity, meaning that the total outstanding loans against their home could actually exceed the market value of their home.  Under this scenario it is impossible for a borrower to refinance and some may choose to walk away from their property and simply allow their mortgage to go into default and ultimately into foreclosure.  The critical year for these borrowers may be 2008 when many of the short term adjustable loans originated in 2005 and 2006 are scheduled to re-set.  An astounding 25% these of adjustable rate borrowers facing interest rate re-sets may have no equity or negative equity in their homes.

What the Feds are Doing in Response

In their most recent two day meeting Fed policy makers likely made the burgeoning problem in the sub-prime mortgage market a priority for discussion.  It is widely believed the Fed will do all they can to curtail the mounting concerns about the sub-prime markets on both Capitol Hill and on Wall Street.  Note that stock markets world-wide suffered a serious blow on February 27th when the DJIA suffered a 416 point drop, blamed in large part on fears of sub-prime related lending losses.  The Feds have elected not to move key interest rates since August of 2006 and are likely to leave rates at a steady 5.25% so that commercial lenders will allow prime interest rates on home equity lines of credit, credit cards and other loans to remain at 8.25%.   It is important to note that while the Fed sets the tone for interest rate markets in general and they do control short term rates, they do not directly control long term interest rates as is commonly perceived.  With about 20% of sub-prime loans expected to go into default, it is unlikely the Fed will compound the problem and further destabilize the housing market by tightening credit.  One positive contrast to the last housing crisis of the 1990's is that the economy today appears to be on stronger ground as jobs are being added and not lost in this economy.

Fannie Mae & Jumbo Mortgage Rates

Just One Click! = Current Rate Chart

Start by selecting your state

Select Your State Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware District of Columbia Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming

How Lender's are Responding

It is unfortunate that just as underwriting standards loosened as home values were soaring, now that prices have stabilized and even declined in some areas, lenders are tightening their underwriting guidelines.   Many lenders are scaling back on loans to borrowers who cannot document their earnings and will no longer provide financing on homes where a borrower does not provide at least a 5% down payment.  In fact investor's appetites for mortgage-backed securities with sub-prime and Alt A loans as the underlying collateral are no longer appealing and demand is rapidly drying up for them.  One positive development is that sub-prime loan servicers seem to be moving quickly in adopting a borrower-friendly approach as loan delinquencies and foreclosures mount.  It is the loan servicers who collect mortgage payments and are left with the task of handling defaults, foreclosures and eventually disposing of the real estate owned (REO's) by the lenders.  The foreclosure process can cost as much as $40,000+ per home to enforce, therefore lenders and servicers are very willing to engage in early stage loss mitigation to help minimize the cost for themselves and their investors.  Early intervention and loss mitigation seem to be the recommended approach before advancing onto foreclosure proceedings as many lenders are attempting to do all they can to avoid foreclosure by working with delinquent borrowers.  Foreclosure mitigation can include counseling, loan modification programs and forbearance.  It's encouraging to note that a full 70% households receiving lender assistance in this area were current on their mortgages 12 months after services commenced. The key to stabilizing a market where 20% of the sub-prime loans are expected to go into default will be to initiate loan modification programs and forbearance plans that really work and minimize delinquency recidivism rates by borrowers.  Borrowers can help by approaching their lender just as soon as problems develop for the longer they delay in notifying the lender of potential trouble, the more complicated things become and then fewer options are available to help them.

Greed was Plentiful - Who's Really at Fault?

There is plenty of blame to go around as expected.  The sub-prime borrowers who argued bitterly that the American dream was not accessible to them because they could not qualify for a loan,  were not complaining as long as housing prices were on the rise but now their complaints are being voiced loudly as the housing market has stalled out.  And the lenders who are the alleged professional risk evaluators have a duty to their shareholders and to their clients to serve and protect their best interests by making sound lending decisions.  Then there is the investor who demanded higher yields in a low interest rate environment and of course to achieve higher yields means taking on additional risk.  And lastly the absence of state and federal regulation, how could they have permitted these risky loans to occur.  Sounds like the most familiar of stories where greed prevailed by all and now that things have gone south the finger pointing will begin and the taxpayers, that is you and me, might be the ones holding the bag again and left to pay the hefty price of another bailout if the Feds, who seemed to turn the other way while this was happening, proclaim we must.  This is a cycle that seems to occur all too frequently as little ever seems to be taken away in terms of “lessons learned” as history continues to repeat itself.

Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.

"I am addicted to Bloomberg TV" says Nancy.