"RealtyTrac™ (www.realtytrac.com), the leading online marketplace for foreclosure properties, today released its 2006 Q1 U.S. Foreclosure Market Report, which showed that 323,102 properties nationwide entered some stage of foreclosure in the first quarter of 2006, a 38 percent increase from the previous quarter and a 72 percent year-over-year increase from the first quarter of 2005. The nation’s quarterly foreclosure rate of one new foreclosure for every 358 U.S. households was higher than in any quarter of last year."
Foreclosures up 38% from last quarter, and 72% from the first quarter of last year? Yikes. (And this has nothing to do with Katrina. RealtyTrac breaks the figures down by state, and foreclosures are way down in Louisiana, Mississippi, and Alabama.)
This fits in with one of my preferred economic nightmare scenarios, which goes like this:
American consumers have gotten us through the last recession and into the present rather half-hearted recovery. They have done so, in large part, by taking on mortgage debt. Because real estate prices have been rising dramatically (my present house turns out to have doubled in value in the six years since I bought it, amazingly enough), this has looked dandy: it's like having a trust fund that an invisible fairy godmother is constantly adding money to.
This, combined with our current nonexistent savings rate, means that we are awash in debt. And that debt is coming in more and more risky forms. For instance, interest-only mortgages:
"when faced with the prospect of having to put off owning a home, buyers have been looking for any way to get in, especially when it means (they hope) a chance to ride the double-digit gains that homeowners have been racking up.
The solution: Borrow 100 percent of the price. Take an adjustable rate. Pay just interest for a few years (or not even that much) and hope to sell for a profit or find a way to pay more later. Whatever it takes.
Banks, meanwhile, are looking for ways to continue to lend money as home prices rise. For both borrower and lender, the underlying assumption is that the market will continue to move in one direction -- up, up, up. In a few years, the thinking goes, borrowers can use their inflated equity to refinance into a safer loan.
Trouble is, there's simply no guarantee that housing prices will continue to climb. And if prices soften and interest rates rise, the abundance of adjustable-rate, interest- only, option-payment and similar loans could backfire in several ways.
For borrowers, the biggest risk is payment shock. Say you buy a $300,000 home, financing 100 percent of the price with an interest-only loan. In five years, if your rate rises just as your principal becomes due, your monthly payment could easily spike by 50 percent. With little or no equity to fall back on for a refinancing, you could be forced to sell quickly or even default on the loan. (What's worse, if your home is worth just 5 percent less, you'll have to come up with $15,000 to pay off your mortgage.)
An uptick in selling, in turn, would push up inventory on the local market, potentially causing prices to collapse."
And people are clearly using these sorts of loans in very risky ways:
"Craig Wolynez is the kind of homeowner stoking fears about a housing bubble.
Even though he had no steady income, the 33-year-old computer consultant and his wife were able to purchase a $416,000 house in the San Fernando Valley two years ago using an "interest-only" mortgage that guarantees low monthly payments for the first five years. After that, Wolynez's payments could rise sharply — making him a prime candidate for default or, even worse, foreclosure.
But like many financially stretched home buyers, Wolynez has a way out: He plans to refinance before his payments balloon. He's now shopping for a new interest-only mortgage that will keep his payments manageable longer."
And that could work if real estate prices keep going up. If not -- if Mr. Wolynez ends up owing more than the house is worth, for instance -- then he's stuck with payments that will balloon in a few years, and no steady income. That sounds like a recipe for foreclosure to me.
I haven't found a source for current national statistics on interest-only loans, but a bit of googling shows them making up a third of new DC area mortgages, and 54% of new mortgages within the district itself, as of May 2005, and "nearly 70 percent of home purchases in the first two months of the year in San Francisco, Marin and San Mateo counties, up from 18 percent in 2002 and 59 percent in 2004" (May 2005). Here's Business Week from May 2005:
"In 2004, fully 50.4% of the mortgage loans issued for purchases of single-family homes in Georgia were to pay interest only. That made the Peach State No. 1 in the nation in its share of interest-only mortgages. But a whole bunch of other states were not far behind: California was second, at 47.1%, Colorado third, at 45.5%, Nevada fourth, at 44.7%, and the District of Columbia, fifth at 43.8%.
Nationwide, the share of mortgages that were interest-only shot up from 1.5% in 2001 to 6% in 2002, 13% in 2003, to 31% in 2004. "
So, to summarize: we have an economy that's incredibly dependent on consumers' ability to acquire mortgage debt. We have consumers who are increasingly indebted. Moreover, their debts are much more likely than a few years ago to take this incredibly risky form: low payments for a few years, and then a huge increase in payments for the next few decades. People who would not assume these risks if they were prudent are doing so. If the housing market keeps soaring, they'll be fine; if not, they'll be screwed. Moreover, some of those loans are about to hit the "jumping payments" point:
"Repayment terms on about $1.3 trillion of adjustable-rate loans will increase in 2006 and 2007, forcing some borrowers to pay up to 150% more per month."
$1.3 trillion? Yikes again.
And guess what? The housing market is cooling down.
Guess what again? We have a brand new bankruptcy bill that means that any of these people who end up declaring bankruptcy will not recover for a long time.
And guess what a third time? Mortgage lenders are not getting any more prudent:
"What's worse, instead of cutting back on the exotic mortgages they've leaned on throughout the boom, many lenders are charging ahead on such high-risk loans full tilt. "Mortgage lending standards show little sign of tightening," says Frederick Cannon, bank analyst with New York's Keefe Bruyette & Woods Inc. investment bank. "[Lenders] should have dialed back the aggressive loans by now."
Cutthroat competition, say banks, leaves them no choice. Even after then-Federal Reserve Chairman Alan Greenspan admonished lenders a year ago for enticing borrowers to take on more debt, many still require little or no documentation, ask for low minimum payments, offer loans that are high as a percentage of home valuations, and permit borrowers to carry more overall debt than in the past. Few lenders have passed much of the rise in rates on to borrowers either. "Both the banks and consumers are stretching," says Peter J. Winter, an analyst with Harris Nesbitt Corp., a unit of BMO Financial Group (BMO ). (...)
About 10% of U.S. households now face a great risk of running into credit problems, according to research done by Meredith Whitney, senior financial institutions analyst for CIBC World Markets Inc. (BCM ). If borrowers start to default on their loans, their lenders could themselves face mounting problems.
It has happened before. In the mid-'90s some banks were so desperate to issue mortgages that they were lending as much as 125% of a home's appraised value. When the economy weakened, several filed for Chapter 11 bankruptcy, including United Companies Financial, which was later liquidated. Caution to those lenders who are pushing the envelope today."
Scary stuff. And it doesn't just hurt the people who actually go into foreclosure. When people can take out mortgages they can't really afford, they bid up prices for everyone. When those prices go down, everyone gets hurt. And when the economy depends as heavily on mortgage debt as it does now, there are very serious risks involved.