The Loans behind Rising Foreclosure Rates
Not too long ago, when a potential home buyer needed to secure a loan, they were pretty much limited to applying for a conventional mortgage These types of loans were generally noted as having a fixed rate and term (15 or 30 years), required mounds of paperwork and a reasonable amount of due diligence on the part of the lender to ensure that the borrower could indeed afford the mortgage without inflicting undo financial hardship. As a result, foreclosures were not a common place occurrence and conventional lenders pursued foreclosure against a borrower only as a last resort. Times have definitely changed and so have the sheer number of foreclosure homes across the country. In July 2007 alone, the total number of U.S. properties either entering or moving through some stage of the foreclosure process was 131,574.
The most recent boom in real estate sparked a frenzy to qualify more home buyers. Many of those buyers had less than perfect credit which often disqualified them from receiving a loan under conventional mortgage guidelines. Enter the subprime lending market which crafted several “creative financing” products for those with less qualifying credit. Subprime loans flourished and quickly overtook the conventional mortgage in popularity. This is clearly reflected in the numbers. The subprime home loan market grew from $35 billion in 1994 to $665 billion in 2005. Subprime lenders claimed that their loans had assisted in boosting U.S. homeownership to a record 69 percent of households. Regrettably, those same lenders have fallen silent as more and more borrowers continue to default on their loans and the volume of foreclosure listings balloon.
So, what types of subprime loans are linked to the rise in foreclosures? Option and Hybrid Adjustable Rate Mortgages (ARMs), as well as no or low-doc loans are the common loan types noted in the increase of foreclosure homes. Hybrid and Option ARMs were attractive to many borrowers because they often offered a low introductory interest rate, no money down or interest only payment teasers. Combine that with lenders who underwrote those mortgages without requiring adequate proof of the borrower’s assets and income and you set the stage for a climb in lender and bank foreclosure rates.
Many critics of these loan products had long protested what they called the predatory terms of these loan products, but it did not stop many borrowers from signing on the dotted line. Maybe they didn’t understand what they were agreeing to or thought that circumstances would change and they could afford a larger loan payment two or three years down the road. However, the reality is that many probably could not realistically meet their loan terms then and definitely can not afford it two and three years later as those terms reset to reflect even higher interest rates and payments.
Loan delinquency rates and foreclosure activity is higher among the Subprime ARM market in comparison to more traditional, VA and FHA loans. According to a Mortgage Bankers Association survey, the rate of foreclosures specifically related to subprime ARMs jumped from 2.7 percent to 3.23 percent for the first quarter of 2007. Compared with the first quarter of 2006, the delinquency rate for subprime loans increased 227 basis points. The foreclosure inventory rate was noted as increasing 160 basis points for subprime loans, while the rate of new foreclosures increased 81 basis points for subprime loans.
The Center for Responsible Lending believes it will also get worse before it gets better. At a March 2007 hearing in front of the U.S. House Committee on Oversight and Government Reform, they predicted that foreclosure rates would increase significantly in many markets and that 2.2 million borrowers would lose their homes and up to $164 billion of wealth in the process. That translates into foreclosures on one in five subprime loans (19.4%) originated in recent years – or approximately one-third of all subprime loans.
The subprime loan market remains in the spotlight and is likely to do so for some time, given that a quarter of all loans are now subprime. It is important to point out that not all lenders providing products in the subprime market condone predatory practices. Many subprime lenders do provide a valuable service to borrowers who may not otherwise qualify for a home. Consumer education, tightened regulation and industry safeguards will hopefully go a long way in ensuring that future homeowners never have to experience the distress of a foreclosure.