Making Sense of the Foreclosure Fallout

Mortgage defaults are on the rise, but risky subprime lending isn’t entirely to blame. Find out the reason for the spike, and most importantly, how you can help clients be financially safe.

May 1, 2007

Foreclosures rose sharply in the first quarter to one filing for every 264 households, according to the latest quarterly report by RealtyTrac, an online database of foreclosure properties.

Obviously, for home owners who are in foreclosure or facing it, the situation can be bleak. But there is some good to come out of this spike in defaults — most notably new policies that lenders and regulators are putting in place to improving the mortgage market for the future.

The current foreclosure environment also opens the door for you to broach the topic with buyers and sellers. Use this chance to educate them on what they can do to avoid foreclosures. I provide some tips for you at the end of this article.

First, What the Stats Say

For the first-quarter of 2007, Realty Trac reported more than 430,000 foreclosure filings, including default notices, auction sale notices, and bank repossessions. That's up 27 percent from the previous quarter and up 35 percent from the first quarter of 2006. Indeed, 37 out of the 50 states reported year-over-year increases in foreclosures.

Continuing a trend from 2006, Detroit documented the highest overall foreclosure rate (16,351 filings and one foreclosure filing for every 51 households) of the nation's 100 largest metro areas. Other metros in the top 10: Riverside-San Bernardino, Calif.; Sacramento, Calif.; Stockton, Calif.; Atlanta; Denver; Bakersfield, Calif.; Fort Worth, Texas; and Dallas.

But be careful before you put all the blame on subprime lending, says James J. Saccacio, chief executive officer of RealtyTrac. “We estimate that more than 50 percent of the foreclosure activity we charted in the first quarter was from subprime loans,” he says. “However, it's not just low-end homes that are going into foreclosure. We're seeing a rising percentage of foreclosures with an estimated market value of more than $750,000."

Should We Have Expected It?

Experts point to many different reasons behind the rise in foreclosures. As Saccacio notes above, there’s more to the story than risky loan-making. Here’s what contributed to the peaking numbers:

  • The Mortgage Bankers Association, in its testimony to Congress last fall, said that homeownership rates are at record levels, nearly 69 percent. It stands to reason that with a higher rate of ownership, there is a higher rate of foreclosure.
  • Delinquency rates typically peak 3 to 5 years after origination, which is in keeping with record home sales and record loans following 2001. In other words, this was to be expected.
  • Approximately 1 percent of all loans are in the foreclosure process, well within historical norms, according to the MBA. That’s still less than the post-recession peak of 1.5 percent just four years ago.
  • Three out of four loans that enter the foreclosure process will not wind up as a foreclosure sale, either because the home owner cures the delinquency, works out a payment plan with the lender, refinances, or sells the home.
  • Somewhere between 0.5 percent and 1 percent of all homes going into foreclosure are owned by subprime borrowers, according to estimates by Walt Molony, spokesman for the NATIONAL ASSOCIATION OF REALTORS®. On the low end, that's one home in foreclosure out of approximately 200, suggesting that high foreclosure rates are not just a subprime problem but due to a wide range of other causes.
  • Finally, subprime borrowers are higher risks and have always had a higher delinquency rate than prime borrowers. Yet, only six percent of home owners are nonprime borrowers with adjustable rate loans that are resetting to higher rates.

On the Bright Side

So what’s the silver lining? Wall Street investors are now requiring better underwriting and increasing the pricing for subprime loans. Federal and state banking regulators have issued guidance to tighten the underwriting standards for nontraditional mortgages and recently proposed similar guidelines for subprime mortgages. Congress is holding hearings that may very well result in the development of new laws to protect consumers.

Also, NAR has a newly adopted Enhanced Subprime Lending Policy, which proposes solutions to avoid repeating mistakes that led to the increases in home owners defaulting on their mortgages.

You don’t have to wait on the sidelines. Instead, NAR's Chief Economist David Lereah advises real estate professionals to be part of the solution. Here are three ways you can help your clients:

  • Learn about new local or state programs. Some states such as Maryland's Department of Housing and Community Development are launching programs that allow certain borrowers to refinance their high-risk mortgages into affordable fixed rate loans. Maryland's program, called “Lifeline,” is aimed at preventing defaults and foreclosures, thereby protecting home values for other home owners. The program allows participating lenders to bundle the new loans and sell them back to the DHCD, which in turn uses cash from a bond issue to buy the bundled loans. Interest paid by the borrowers pays off the bonds.
  • Check with lenders on new products. Ask if they have any new loan programs that could be helpful to borrowers in a volatile housing market. For example, Washington Mutual Inc. has just announced a new combination mortgage/home equity line of credit that allows customers to reset interest rates or switch between fixed and adjustable rates up to twice a year without having to refinance. The first reset is free, and $250 afterward.
  • Educate your buyers. NAR has developed several brochures to help clients understand their mortgage options, including those for homebuyers with less-than-perfect credit. The FHA and VA have recently made significant improvements to their programs that can be valuable financing tools for many homebuyers (stay alert to lenders in your area offering these products). NAR also has brochures describing the recent changes to the FHA program that may benefit your clients and help them avoid predatory lending.

(c) Copyright 2007 Realty Times. Reprinted with permission.

Blanche Evans is a writer/editor and CEO of evansEmedia. Formerly, she was a senior editor with Realty Times, where she was named by REALTOR® Magazine as one of the most influential people in the real estate industry.