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Wednesday, Feb. 21, 2007 | The number of San Diego County homes in some level of foreclosure activity reached 1,150 last month, according to RealtyTrac, a nationwide tracker of foreclosure data. That’s up 20 percent from January 2006 and up more than 240 percent from the first month of 2005.
Many analysts and economists see the rising foreclosure activity as an indicator of more trouble ahead for an already slow housing market. They point to the types of risky loans that became popular during the housing boom — and persist in popularity as prices remain otherwise out-of-reach for many buyers — as likely contributors to the increased trouble. Recent months’ data look especially dramatic because during the super-heated housing market, borrowers in trouble could often avoid foreclosure by selling at a profit. That resulted in a significantly low foreclosure rate in the county.
But even as the market has slowed, the popularity of risky loans has spread. New data for San Diego County reveals that 67 percent of loans made in the first 11 months of 2006 were interest-only or negatively amortized. That means borrowers pay low introductory payments until a reset period comes a few years later, significantly increasing their monthly mortgage payment. Of that 67 percent, 30 percent were negative-amortization loans, a threefold increase since January 2004 and 30-fold jump since January 2003, according to FirstAmerican Loan Performance.
And another segment of the mortgage market has moved into the spotlight in recent weeks. Subprime loans are made to borrowers with damaged or weak credit who wouldn’t have otherwise qualified for a mortgage. About 14 percent of the loans outstanding in California as of September are subprime, according to the Mortgage Bankers Association.
Unexpected levels of delinquencies on this type of loan have worried investors who back subprime lenders. Earnings losses have sent some such lenders into bankruptcy, while others are starting to tighten standards and more strictly enforce underwriting guidelines. Some are eliminating subprime practices made popular in the housing boom — like allowing borrowers with spotty credit to get loans to cover the entire cost of a home, or not verifying a borrower’s ability to handle a loan by checking income and assets. Last week, a San Diego-based subprime lender, Accredited Home Lenders, joined the ranks of such companies by vowing to tighten standards after reports of significant losses last quarter.
Rick Sharga of RealtyTrac said he’s noticed the link between the lenders’ stricter regulations and the rate of foreclosure activity. “I think the two go hand-in-hand,” Sharga said.
Foreclosure activity includes anything from the 950 notices mailed last month to county borrowers who’d missed at least one mortgage payment to the 70 local borrowers’ houses seized by banks.
Sharga said that, anecdotally, adjustable-rate loans are more likely to default than fixed-rate loans, and that subprime loans default at a higher rate than prime.
The adjustable-rate and subprime loans usually start out charging borrowers a low monthly payment and then ramp up after a few years. Unless borrowers are savvy and can refinance their loan at a more predictable, fixed-rate loan before the reset period, they will have to start paying significantly more each month. When borrowers are unable to do that, they may miss a payment or two and thus enter the first stage of foreclosure.
But some industry analysts say the reports of subprime lenders’ actions are being blown out of proportion. Mortgage analysts don’t have enough evidence that the risk associated with these loans warrants such dramatic responses, said Jay Brinkmann, vice president of research and economics at the Mortgage Bankers Association. He said the subprime lenders’ moves are anticipatory, responding to concerns from their investors, who fear that defaults will increase dramatically.
“If a lender sells a loan to an investor, if there’s any indication of problem on that loan, the investor’s going to be afraid of how they might perform in general,” Brinkmann said.
During the boom, as values shot to record levels and available properties were snatched up soon after the for-sale stakes were planted in lawns, mortgage lenders rushed to add staff and widen their offerings to garner as much business as they could. First-time homebuyers, attempting to enter the market without any equity to carry forward from another property, signed up for loans that allowed them to borrow 100 percent or more of the purchase price of the home. Lenders loosened their standards, approving borrowers for loans they wouldn’t have previously qualified for. Stated-income and low- and no-documentation loans gained popularity, excusing lenders from verifying consumers’ income and assets.
But now, home values have stopped appreciating in double-digit jumps and pricing in some areas has leveled or even declined. Last month, the median sale price for a home in San Diego County was 5.6 percent lower — nearly $30,000 — than the $500,000 price logged in January 2006, according to DataQuick Information Systems. That decreased value means that many who took out mortgages to cover the entire cost, or more, of their homes now owe more than they could sell their homes for.
Though the lag time in data collection means the current status of the San Diego housing market is murky, analysts agree the stage is set for a number of events that could exacerbate the market’s woes.
One, said Paul Leonard at the Center for Responsible Lending, is that increased home prices meant people were stretching further than ever past their incomes just to get a loan for a home. In a report published in December, the center stated that the default rate for subprime loans made between 1998 and 2001 was 3.2 percent in San Diego County.
But for the nearly 5,000 such loans originating in 2006, the center predicts that 21.4 percent are headed for default.
“There are some fundamental flaws in the underwriting process that are coming back to haunt lenders,” Leonard said. “There are market corrections going on, but an after-the-fact market correction doesn’t do much for borrowers who maybe shouldn’t have gotten a loan in the first place.”
Ideally, subprime loans function as a credit management tool for clients with weak or checkered credit histories. The loans often have a two-year introductory period of a low payment that also consolidates whatever other debt the client may have, like credit cards. That gives the clients two years to get into a home and start pulling their finances together. And usually, the best option for them at the end of those two years is to refinance into a more traditional, fixed-rate loan, said David Maiolo, mortgage broker with Ocean Mortgage.
Maiolo said the lack of training for mortgage brokers who delved into subprime lending during the boom meant that too many loans were made to people who could barely afford the introductory low payments. As a broker of loans for subprime clients himself, Maiolo said he feels many similar clients weren’t counseled to refinance in time to avoid the costly, ramped-up payments down the road.
“Within the industry, [subprime] should be approached as a ‘band-aid’ loan,” he said. “It’s designed to make their overall monthly payment much more manageable. At the end of two years it’ll jump. And they have to plan on refinancing after two years.”
As opposed to the subprime market, Maiolo said he hasn’t seen much in the adjustable-rate mortgage market to worry him so far. “Once things get tight, people will make an extra effort to keep their home,” he said.
That test may not come in full force for a couple of years, since the introductory period for many adjustable-rate mortgages is at least three years, and 2005 was the first year more than 20 percent of the county’s loans were negative-amortization.
Brinkmann said he thinks the extent to which lenders are tightening their standards constitutes over-regulation. And in a slow market, restricting the number of people who qualify for loans also restricts the number of people out scouting open houses and attempting buy up of the standing inventory in the market.
“Over-regulation tends to shrink the pool of potential buyers,” Brinkmann said. “You can’t restrict the supply of homes on the market, and so you have demand and supply imbalances.”
But Maiolo said he welcomes any recognition by major lenders that brokers have been too lax. He said maybe that will take some of the stigma away from the non-traditional loan products, which he feels have received a bad rap.
“I don’t necessarily think there’s any bad loans out there,” Maiolo said. “Just too many lenders who aren’t responsible.”
Leonard agrees. “There are a lot of folks who’ve sought homeownership as the ultimate tool in accumulating wealth, who were sold products that were inappropriate and unsuitable,” he said. “The lenders seemed to count on appreciation rather than the people’s actual income.”
(Correction: The original version of this story incorrectly used the RealtyTrac foreclosure data as aggregate information for the entire market. It should have simply reflected the foreclosure activity for the individual month. We regret the error.)