Foreclosures: Down, but not much longer

WASHIINGTON -- Aug. 10, 2006 -- Those easy mortgage chickens are coming home to roost.



This fall the adjustable-rate mortgages [ARMs] that millions of Americans took out during the recent housing boom will be reset, and many homeowners will see their monthly mortgage payments shoot up by as much as 20 percent. According to the Mortgage Bankers Association, of all mortgages financed in 2005, 36 percent were ARMs -- the highest ever.



This is a matter of concern because ARMs are typically initially made at a lower rate and then increase after a fixed period of time, usually 1, 3, 5, 7, or 10 years, after which the rate will more closely reflect current rates. As interest rates increase, mortgage payments increase. Between $400 billion and $500 billion in ARMs are due to be reset by the end of 2006. The following year will be even more dramatic, when more than $1.5 trillion will be reset.



For many Americans, this is scary news, if hardly unexpected. Everyone who took out an ARM or another equally appealing low-rate mortgage over the past few years to buy a house, at times beyond their means, knew that someday their payments could balloon. Those home buyers may have thought they would be able to flip their houses quickly and avoid the rise in their mortgage payments. But now, many of them are finding themselves stuck in a house they may soon no longer be able to afford, and, as the real estate market peters out, there's little they can do about it.



Indianapolis' dubious honor

The result is that these homes, instead of being a springboard to greater wealth, suddenly become an anchor. Unable to pay their mortgage, and hit by the double whammy of higher gas prices and higher credit-card rates, many Americans in nearly every income bracket may be forced into foreclosure.



According to a new study by RealtyTrac, which publishes the nation's largest database of pre-foreclosure and foreclosure properties, the situation is not all that bad -- yet. In their survey of foreclosure rates in the 100 largest metropolitan statistical areas [MSAs] in the U.S., the second quarter of 2006 actually saw fewer foreclosures than in the first quarter. While Indianapolis, Atlanta, and Dallas saw the nation's three highest metropolitan foreclosure rates, other areas, such as Chicago and Portland, Ore., saw a 60 percent and 188 percent decline, respectively, from the first quarter.



Indianapolis found itself at the head of the list. Even though its foreclosure rate wasn't as high in the second quarter as in the first, it still performed worse than any other metro area in the country, with nearly 0.987 percent of all its homes in foreclosure, or one foreclosure for every 101 households.



Worse predicted

The next worst performer was Atlanta, with 0.904 percent of all homes in foreclosure, or one home in every 111 households. The reason that Indianapolis and Atlanta have such high rates is due more at this point in time to local market conditions than to ARMs. Indianapolis, for example, has a weak job market and a weak real estate market. On average, homes there take twice as long to sell, and then often for a fraction of the market value.



Atlanta, on the other hand, has suffered because of both an exceptionally high number of bad mortgages that were being written as well as the fact that many of the industries there are retrenching, which leads to job loss or salary reductions.



"I think the findings of this report are a message that people should take a deep breath and stop hyperventilating," says Rick Sharga, RealtyTrac's vice-president of marketing. "The feared tsunami of foreclosures isn't taking effect yet."



But Sharga also predicts that the third and fourth quarters are going to be much worse. "Year-to-date, we have seen a 39 percent increase in foreclosures over last year," he says. "I'd be very surprised to see the rate drop below that especially with the 3/1 and 5/1 ARMs resetting in the fall."



Unprecedented situation

A 3/1 ARM has a fixed interest rate for the first three years, and thereafter adjusts each year. A 5/1 ARM is fixed for the first five years and then resets. A major concern is that the number of ARMs issued at subprime rates to borrowers with lower credit ratings is not known. "We know that ARMs default at a higher rate than fixed, and subprimes default at higher rates than primes," says Sharga. "Never have so many ARMs reset at the same time. There is no precedent for it."



Many industry observes are concerned that the default rate could reach dangerous economic proportions. Government-sponsored enterprises [GSEs], such as Fannie Mae (FNM) and Freddie Mac (FRE), as well as lenders such as Countrywide Financial (CFC) and Wells Fargo (WFC), are all looking at foreclosure prevention strategies, according to Sharga. "The GSEs and lenders are developing novel solutions on workout programs to prevent people from going into foreclosure," he says. "Because if the number of foreclosures is too great, it drives down the market and they find themselves stuck with a lot of depreciating property on their hands. It is much more in their interest to educate homeowners on what their options are and come up with ways to help them keep their homes."



While many Americans will almost certainly find themselves in foreclosure, for others this could represent an opportunity that had been denied them in recent years, as prices climbed around the country. It's important to note that foreclosure laws are not federal, and so each state, as well as the District of Columbia, is different. In New York, homeowners have 455 days between the time they're delinquent on their loans and the time a lender can foreclose. In Texas, this pre-foreclosure period is 27 days, the shortest in the U.S.