The Morning Report
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As a wave of foreclosures douses cities across the country, community leaders are increasingly blaming the types of loans people used to get into their properties. Many worry that fallout from the lax lending practices of the past few years mean that foreclosure rates will only continue to rise.
Frequently barred from traditional financing, Latinos and other minority groups were targeted by brokers for high-interest loans during the housing boom.
A concerted push for homeownership for Latinos and subsequent, unprecedented gains on that front coincided with a dramatic run-up in home values this decade. But some fear the minorities will have sustained a net loss of homeownership after foreclosures are tallied nationwide.
The sector of the mortgage market catering to low- or poor-credit consumers, called subprime mortgages, saw tremendous trouble in the first few months of 2007. The sector exploded in 2005 and 2006, popularizing loan options where borrowers didn’t have to have verifiable income or assets. Many used very little or none of their own money toward the purchase of the home, usually borrowing one loan to cover 80 percent of the home and another to cover 20 percent: their “down payment.” Because of the higher risk involved in lending hundreds of thousands of dollars to a borrower with a low credit score, lenders charged exorbitant interest rates on these loans.
Lenders were able to so loosen the standards because of a phenomenon known as mortgage-backed securities. Lenders would make these risky loans, then cut them up into chunks, lump them together with other loans, and sell them in a pool to investors. That spread out the risk, and allowed loan officers to more freely dole out money to people who otherwise might not have been able to make their first payment.
Several subprime lenders folded entirely or drastically reduced their offerings to such consumers in the first few months of 2007 after it was reported that subprime borrowers were defaulting on their loans at disproportionate levels.
For many during the first few years of the decade, the region’s sizzling real estate market appeared to be an unstoppable train that must be caught at any cost. Prices appreciated in double digits year after year in many areas in the county, giving existing homeowners a giant boost in available equity, and dangling a carrot in front of those who did not yet own a home. Some senior citizens have seen so much equity amass in their homes that they are increasingly tapping it to bankroll their retirement.
The speed of the market, with buyers flinging bids of tens of thousands of dollars more than sellers were asking, inflamed many of those first-time buyers, who worried they’d be priced out forever if they didn’t dive in to the market immediately.
But that same housing appreciation that had benefited existing homeowners served to place homes out of reach for many buyers, in relation to their incomes. Rather than see the market calm down from its frenetic pace and risk ending a period of some of the greatest profits ever for home finance companies, lenders offered loan options that would let a buyer into the market at extremely low payments, using for a rhetorical safety net the equity that many were sure would amass in the homes.
The popularity of such adjustable-rate mortgages, many of which allowed buyers to pay just the interest on a home, or not even the whole amount of interest accruing each month, grew in 2004, 2005 and 2006, even as real estate peaked and began to cool. The option to pay less than the interest accruing is called negative-amortization, and actually adds to the homeowner’s debt even while the payments are being made. Negative-amortization and interest-only adjustable-rate mortgages — called “exotic loans” — lock borrowers into low payments at the start of the loan with low interest rates for a set period, usually about three years. Then, the payments ramp up to include portions of the principal, and the interest rate varies according to a pre-determined market index. In many cases, borrowers are stuck with payments that can be more than double their introductory monthly bill, and rising interest rates mean the payments often go up even more.
But the idea behind the adjustable-rate loans was to get out of them before that pain set in. Ideally, homebuyers would take out the adjustable-rate mortgage, make the low payments for three years, then refinance, using the equity — sometimes six figures’ worth — as a boost into a more traditional loan, with fixed rates and payments. That worked well for thousands of people who enjoyed dramatic price appreciation during the housing boom.
However, for many who jumped into the market near the end of that appreciation streak in 2005 or 2006, the reset period is just starting. And in the time since they bought their homes, prices haven’t shot up to form the equity safety net. Increasingly stuck with ballooning monthly payments, many are finding it difficult or impossible to refinance or sell their homes without losing money. The mortgage default and foreclosure rates have zoomed to near-record and record levels, respectively, as the group of distressed homeowners swells.
The trouble all around has many consumer advocates and even some in the lending industry calling for tighter regulation of mortgages and loan officers. Economists say the impact of foreclosures on the housing market will be clearer in late summer 2007, when a large portion of the exotic and subprime loans are hitting their reset period. In the meantime, tighter regulation on who qualifies for a home loan will shrink the pool of buyers able to get into the market at all, which could trickle up as fewer homeowners are able to move up in the market.