February 18, 2008
The Place We Never Suspected the Credit Crisis to Spread
Posted by Erin Brereton on July 15, 2007
When homeowner-related credit issues began, they involved subprime borrowers–people with less than perfect credit–prompting criticism when the government stepped in with its Hope Now program to help those homeowners avoid foreclosure.
Some asked, why should we help homebuyers who over extended themselves? Isn’t that their problem?
Well, according to a recent New York Times article, it’s now everybody’s problem.
Decreased home prices and stricter lending standards have pushed some homeowners with good credit backgrounds behind on their payments–less than the 24 percent of subprime borrowers which are delinquent or in foreclosure, the Times says, but in some areas, still a staggering amount.
For example, Arizona: The Mortgage Bankers Association found that between the third quarters of 2006 and 2007, ARM-related prime homeowner foreclosures rose 902 percent in Arizona, according to BusinessWeek.
And, all the while, subprime loans continue to do their damage. The MBA says that while subprime ARMs represent just 6.8 percent of the current loans, they comprised 43 percent of the foreclosures initiated during the third quarter of 2007.
(Interestingly enough, a ripple effect is occurring in the U.K.; more than half of the foreclosure orders are subprime borrower-owned homes, despite the fact that–as in the U.S.–they’re just 6 percent of all U.K. mortgages, according to a BBC News report.)
Mortgage payments aren’t the only trouble prime borrowers have stumbled into lately. If they aren’t defaulting on their home loans, the Times says, the prime borrowers are falling behind on their auto loans and credit card payments–at an increasing pace.
And that’s about the last thing that the housing market needs.
“This collapse in housing value is sucking in all borrowers,� Mark Zandi, chief economist at Moody’s Economy.com, told the Times.
Why is it happening? Many subprime and prime borrowers took out the same kind of loans–adjustable rate mortgages (ARMs) that reset to a higher rate after several years of lower payments–so prime borrowers are just as susceptible to sudden higher post-reset payments as subprime borrowers.
When home prices were rising, both groups had more leeway to refinance or sell; now they are both facing high resets. The bottom line? Too many loan programs allowed too many homeowners to buy homes out of their comfort level with little to no money down on the hopes the market would keep rising–and it didn’t.
Why is it a problem? Because prime borrowers carried the weight of the subprime borrowers–for awhile, they were thought to be balancing out some of the subprime defaults, according to the Times.
Where is it happening? The states with the highest increase in prime ARM foreclosure starts in the third quarter of 2007–Florida, Nevada, California and Arizona (which would help explain that horrific rise in prime homeowner foreclosure starts)–have a large amount of investment properties that were purchased to flip and make a profit, according to BusinessWeek.
Arizona had the eighth highest foreclosure rate in 2007; Nevada and Florida ranked No. 1 and 2, according to RealtyTrac.
And–unfortunately–those aren’t the only places experiencing prime problems.
The causes are similar to the factors that pushed the subprime sector into rocky waters. And–even though considerably less troubled prime borrowers exist–the prime defaults are cause for concern.
What’s next?
Well, according to the Mortgage Bankers Association, the highest rate of prime mortgages since the MBA began tracking prime and subprime mortgages in 1998 were delinquent or in foreclosure at the end of September.
As the country tries to spur residential building and the housing market by unloading some of its housing supply, it’s not helping that we’re adding foreclosed properties to the number of homes on the market. Nearly half the home sales in some parts of California recently involved foreclosed houses, according to USA Today.
However, some help–along with measures to prevent the situation from happening again–is on the way, in the form of:
Reduced Rates. The Fed has cut short term interest rates, which should help ease reset rates.
More realistic home equity credit. Banks are also starting to cap home equity lines of credit–in Florida, one of the prime- and subprime-damaged states, some lenders have moved to making home equity loans based on 90 percent (or less) of a home’s value instead of 100 percent, the Florida Times-Union reported recently.
Increased consumer credit monitoring. In addition, credit card companies are reducing limits–and increasing penalties–for high-risk customers, which may help curb growing debt in the future (although it will undoubtedly cause problems at first).
USA Today reported in early February that Bank of America plans to periodically review consumers and raise rates on some they perceive to be a risk–not necessarily because of the current mortgage issues, but some analysts say is related to overall lender losses. Consumers are, after all, falling behind on all sorts of payments.
A plan to prevent foreclosure. And then there is Project Lifeline, the new plan announced by Bank of America, Citigroup, Countrywide, J.P. Morgan, Washington Mutual and Wells Fargo last Tuesday, which pledges to help foreclosure-facing borrowers work out a way to keep their home.
However, the plan is barely a week old and has already come under criticism from the Center for Responsible lending, which called it a “rope that is too short” due to its limitations, which exclude anyone who has missed more than three months of payments and has a foreclosure date less than 30 days away.
If more prime borrowers become entrenched in the subprime cycle, the blow to the economy could be unimaginable.
Have we seen the worst of the damage? It’s hard to say. After all, did we really predict the full extent of the subprime fallout when it started?
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