Friday, December 22, 2006

Fallout Seen From Subprime Lender Abuses

1 in 5 subprime loans in trouble, report says

2.2 million borrowers seen as likely to lose their homes
By Ron Nixon
NEW YORK TIMES NEWS SERVICE
December 20, 2006

About one in five subprime mortgages made in the past two years is likely to go into foreclosure, according to a report released yesterday, with Southern California among the regions expected to be hard hit.

About 1.1 million homeowners who took out subprime loans in the past two years will lose their homes in the next few years, the report said. The foreclosures will cost those homeowners an estimated $74.6 billion, primarily in equity.

The report, written by the Center for Responsible Lending, a research group in Durham, N.C., was based on data supplied by Moody's Economy.com. Researchers examined more than 6 million mortgages made from 1998 until the third quarter of 2006 in the first nationwide study on the performance of subprime mortgages.

The highest default rates are expected to be in cities in California, Nevada, Michigan and New Jersey as well as Washington, D.C.

The report projected that 22 percent of subprime loans issued in Los Angeles/Long Beach in 2006 will end in foreclosure.

The report offers a somber assessment of loans that had helped millions of Americans with blemished credit attain homeownership. About 2.2 million borrowers who took subprime loans from 1998 to 2006 are likely to lose their homes.

Subprime loans are made to borrowers with unfavorable credit histories. They have interest rates that are higher than the prime rate and carry higher fees and pre-payment penalties than other mortgages.

Foreclosures
Top 10 largest increases in expected subprime foreclosure rates:
Region Projected foreclosure rate Projected percent change
Santa Ana-Anaheim-Irvine 22.8 668%
Santa Barbara-Santa Maria 19.6 596%
San Diego-Carlsbad-San Marcos 21.4 567%
Santa Rosa-Petaluma 21.1 527%
Napa 16.4 527%
San Francisco-San Mateo -16.7 462% Redwood City
Oxnard-Thousand Oaks-Ventura 17.6 453%
San Luis Obispo-Paso Robles 13.6 416%
Salinas 20.4 413%
Vallejo-Fairfield 23.8 405%

SOURCE: Center for Responsible Lending

Mortgage companies, banks and investors began aggressively marketing and trading the loans in the early part of the decade because their higher interest rates make them more profitable.

As a result, subprime loans now make up more than one-quarter of the mortgage market, more than $600 billion in 2005.

“This is no longer a niche part of the market that can be dismissed,” said Keith Ernst, senior housing counsel at the research center and one of the authors of the report. “It's a major component of the mortgage market, and the growing rates of foreclosures should be a cause for alarm.”

Much of the greatest exposure to foreclosure risk was found to be in California and Nevada. Of the 10 cities deemed most at risk, only two were outside the two states. Merced led the list with a projected rate of 25 percent, followed by Bakersfield at 24.2 percent.

With a rate of 21.4 percent, San Diego placed 21st among the cities surveyed. Places with rates expected to be greater included Las Vegas, 23 percent; Washington, D.C., 22.8 percent; Riverside/San Bernardino, 22.6 percent; and Los Angeles/Long Beach, 22 percent.

Ernst said San Diego and other Western cities are catching up to what has happened in housing markets in Ohio and other Midwestern states where subprime lending has become a significant problem.

“In many parts of the country, housing markets have been fairly weak for some time, and the subprime foreclosure rate is 15 to 20 percent,” he said. Even more at risk are those borrowers who took out subprime loans that were based on stated incomes or minimal documentation, he said.

John Karevoll, a real estate market analyst for San Diego-based DataQuick Information Systems, said he had not studied the report, but that its projection for the San Diego area “doesn't sound too far out.”

Karevoll said there is no uniform definition of a subprime loan, which he described as “basically a loan given to people who don't qualify for mainstream loans.”

He said the report's findings “may not be as dramatic as it looks,” and instead might illustrate a market that is normalizing after an unprecedented run-up in prices, during which foreclosures were abnormally low due to continuing equity gains by home owners.

“San Diego saw the (price) surge earlier than others,” Karevoll said. “Foreclosure rates went way down, as low as you can get.”

Gary Wong, senior vice president of residential lending for Union Bank of California in San Diego, agreed that the foreclosure rate in San Diego was rising, but from a small base.

He said subprime loans “frequently have features not beneficial to a customer and are sold to people who should not take these loans.” Union Bank is not a subprime lender, he noted.

But Ed Smith Jr., a Mission Valley mortgage broker and director of the California Association of Mortgage Brokers, said subprime loans are not necessarily a bad product.

“They have put more people into homes who wouldn't qualify for traditional products,” he said.

Report author Ernst agreed that the loans might have opened the door to homeownership to many.

“The problem is the loans in the subprime market are being made on risky terms and very risky circumstances,” he said. “The pendulum may have swung too far.”

Smith said that for subprime borrowers, the goal should be to transition into more conventional lending products.

“Many have not planned ahead,” he said. “Now their (home) values are plateauing and interest rates are rising a bit. That's a bad cocktail.

“The key is that people need to be judicious in the use of these products and make sure and sit down and analyze them and ask, 'Is this the right product for me?' ”

The report cited several factors for the increase in subprime mortgage foreclosures – including adjustable-rate mortgages with steep built-in rate and payment increases, pre-payment penalties, limited income documentation and no escrow for taxes and insurance. The report said the features cause a higher risk of default regardless of the borrower's credit score.

“This means that people are not going into foreclosure just because they have low incomes,” Ernst said. “The foreclosures are higher than they need to be because a number of loan features in the subprime market place borrowers at unnecessary risk.”

San Diego Tribune Home Editor Carl Larsen contributed to this report.

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