Justin Schneider
July 04, 2007 09:28 pm
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justin.schneider@heraldbulletin.com
Home ownership is the cornerstone of the American dream.
But subprime lending has put that dream in jeopardy for millions of Americans.
The first quarter of 2007 saw mortgage delinquency rates hit an all-time high, according to data compiled by Equifax and analyzed by Moody’s Economy.com. Default rates on mortgages rose to 2.87 percent, the worst levels since the 2001 recession.
The Center for Responsible Lending projects that one-fifth (19.4 percent) of borrowers who entered subprime loans over the past two years may enter foreclosure soon, causing 2.2 million consumers to lose their homes and resulting in a loss of up to $164 billion in wealth.
Randall Woodruff, bankruptcy trustee for Madison County, serves on a panel of bankruptcy trustees for the southern district of Indiana. He said subprime lending has been a main culprit in the massive foreclosure rate sweeping Anderson and other Central Indiana communities.
“If you are in foreclosure, there aren’t many ways to get out of that problem other than to file for bankruptcy,” said Woodruff, who sees every bankruptcy filed in Madison County. “Whether it’s subprime lending, my gut instinct is that it certainly is one of the problems. The fact that we have so many folks buying homes that they really can’t afford and obtaining mortgages that are going to adjust is clearly one of the main causes of bankruptcies.”
The Wall Street effect
Subprime loans have been part of the mortgage industry since 1995, when the housing market was booming. They provide loans at higher-than-average rates for borrowers with bad credit.
Investors generally agree that home ownership is among the best paths to building wealth, and adjustable rate mortgages, or ARMs, a calling card of subprime lending, have helped some consumers do just that. ARMs usually provide a low introductory interest rate for a period of around two years before the rate increases, taking payments with it. In a hot real estate market, a first-time homebuyer could theoretically take out an ARM, pay the mortgage for two years and sell the home for a profit.
But the housing market has suffered in recent years, and that is one reason subprime loans have garnered headlines of late.
Joseph Clark is a certified financial planner and managing partner at Financial Enhancement Group LLC of Anderson.
“When housing prices were climbing and interest rates were lower, it was easier for homeowners to pay for existing loans by selling their home or refinancing with easier terms,” Clark told The Herald Bulletin. “Now that housing prices are flat or even falling in some markets and interest rates have increased, some borrowers are falling behind.”
Some analysts say the crisis surrounding subprime lending has been exacerbated by Wall Street investors, who used to have little to do with the housing market.
Today, Wall Street firms provide capital for mortgage firms to make loans. The firms then pool the stream of money from loans into bonds known as mortgage-backed securities, which are sold to investors. Pooling the loans creates a cushion against defaults by diversifying the risk.
Selling subprime loans off as securities has given lenders incentive to take unnecessary risk and approve loans they normally would not.
In May, Federal Reserve Chief Ben Bernanke said some lenders focused more on feeding the marketplace than on the quality of loans, in part because risk was passed to investors. As a result, he said, “mortgage applications with little documentation were vulnerable to misrepresentation or overestimation of repayment capacity by both lenders and borrowers.”
Loan defaults stayed low through 2005, even as subprime lending thrived. Wall Street pooled a record $508 billion in subprime mortgages in bonds that year, according to Inside Mortgage Finance, but the figure slid to $483 billion last year as the housing market slumped and subprime defaults picked up.
Now some buyers of mortgage-backed securities are suing investment banks who, in response, are suing mortgage companies. And it appears the bottom has fallen out from under subprime lending. The volume of subprime mortgages is expected to drop by around 30 percent this year, according to the Mortgage Bankers Association in Washington, D.C.
Accepting responsibility
Patty Kuhn, executive officer for the Anderson-Madison County Association of Realtors, said that as local lenders offer attractive loans, borrowers with poor credit are encouraged to buy more house than they can afford.
“There are so many programs out there for no money down,” Kuhn said. “Borrowers are able to buy homes for no money down. They’re government-insured homes, but if you get a little blip in your life, an illness or a divorce, it’s easy to walk away from homes when there’s no money down.”
Kuhn said the high number of foreclosures in the area has driven prices down, painting an exaggerated picture of the housing market.
“Foreclosure rates in Anderson and Madison County have put a glut of properties on the books and then, of course, they sell for less than they normally would,” said Patty Kuhn, executive officer for the Anderson-Madison County Association of Realtors. “It brings the average sale price down, so things look worse than they really are.”
Kuhn said sellers are still getting around 96 percent of their asking prices.
Anderson bankruptcy attorney Larry Robbins said consumers must accept their part of the responsibility.
“I think, maybe, they just failed to read the fine print,” Robbins said. “The real estate market has gone down, and people can’t sell real estate for enough money to pay off their mortgage. It’s not that uncommon.”
Meanwhile, he said, it has become more difficult for consumers to file bankruptcy.
“They just did a major revision back in October 2005,” Robbins said. “I think they’ve gone too far. More notices and disclosures, more requirements have been put on debtors. Right before the law changed, there was a great glut, and it slowed down everybody.”
Emerging from crisis
The NAACP and other civil rights groups have called for a moratorium on foreclosures, but that seems unlikely. Meanwhile, the Federal Reserve has held public hearings on whether to draft tighter subprime lending rules and standards for what constitutes an affordable loan.
The Federal Reserve has taken a more active regulatory stance on subprime loans, and 30 states have adopted recent Fed guidelines on higher-cost loans. Robbins said more rigid disclosure laws could head off loan defaults and bankruptcy before consumers lose control.
If foreclosure appears imminent, consumers can take steps to protect themselves.
Michael Eisenberg, a CPA and personal financial specialist with the American Institute of Certified Public Accountants, has some tips. He recommends informing the lender in case of late payment, find out how foreclosure will impact a credit score and keep accurate records.
Consumers may find alternative solutions by working with lenders.
“When you are in this kind of situation, don’t be afraid to ask for a forbearance,” Eisenberg said. “A forbearance is a request to suspend your payment or to temporarily reduce your payments for a short period of time. If you request this, be sure to have documentation that you are trying your best to pay the bills. These documents may include recent pay stubs, a letter of intent if you recently accepted a new job, and bank account statements.”
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Subprime lending
By the numbers
2.87 percent
Mortgage delinquency rate in the first quarter of 2007
19.4 percent
Subprime borrowers over the past two years expected to enter foreclosure
2.2 million
Number of consumers expected to lose their homes
$164 billion
Loss of wealth for consumers
— Source: The Wall Street Journal, The Center for Responsible Lending
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