Quarterly Foreclosure Rate Again Sets Record
Defaults May Hurt Home Prices, Overall Economy

By David S. Hilzenrath and Dina ElBoghdady
Washington Post Staff Writers
Friday, September 7, 2007

The percentage of mortgages entering foreclosure rose to a record level during the three months ended June 30, according to a survey released yesterday.

The defaults left homeowners struggling to hold onto their houses and threatened to put added pressure on already-weakening home prices.

However, the pain was far from evenly distributed.

If not for increases in foreclosure filings in California, Florida, Nevada and Arizona, the nationwide rate would have dropped from the first quarter of the year to the second, according to the quarterly survey by the Mortgage Bankers Association. Thirty-four states experienced declining foreclosure filings, and others showed modest increases, the industry group said.

"If current conditions persist in mortgage markets, the demand for homes could weaken further, with possible implications for the broader economy," Randall S. Kroszner, a member of the Federal Reserve Board of Governors, said in a speech yesterday.

The survey found that 0.65 percent of the approximately 44 million mortgages covered in the survey went into foreclosure in the second quarter, the highest percentage since the group began tracking comparable numbers in 1972. The seasonally adjusted percentage was up from the prior record of 0.58 percent in the first quarter of 2007 and 0.43 percent during the second quarter of last year.

Foreclosure proceedings generally begin months after borrowers fall behind on their mortgage payments. In some states, the foreclosure process can take a year or more to run its course, and many delinquent borrowers hold onto their homes by negotiating for more-manageable payment terms.

Overall, about 6.5 percent of homeowners who have mortgages are not paying on time, according to Douglas G. Duncan, the association's chief economist. More than a third of homeowners do not have mortgages.

Among the hardest-hit states have been Michigan and Ohio, whose real estate markets reflect the weakness in their industrial-based economies. In Maryland, Virginia and the District, delinquencies and foreclosure starts have been significantly lower than the national averages.

The survey does not show how many of the homes that enter the foreclosure process are lost through foreclosure or how many families avoid public foreclosure proceedings by giving up their homes voluntarily.

The defaults were heavily concentrated among adjustable rate loans, and, when compared with the first quarter of the year, the serious delinquency rate fell slightly for subprime loans with fixed rates.

By some measures, the picture was worse as recently as five years ago, when the real estate market was showing lingering or delayed effects of recession and the bursting of a stock market bubble.

For example, the percentage of mortgages past due by 30 days or more -- but not in foreclosure -- was higher in 2002.

However, in the current market, borrowers who fall behind on their payments may have a harder time recovering. Just as rising home prices and the availability of easy credit fueled the housing boom, declining prices and tighter credit have made it more difficult for borrowers to get out of trouble by refinancing or selling their homes.

"Now if you put a 'for sale' sign on your lawn, it's just as likely to gather moss as it is to gather buyers," said Nicolas Retsinas, director of Harvard University's Joint Center for Housing Studies.

The increase in defaults can be traced largely to a loosening of lending standards and a proliferation of nontraditional loans that made it easy for borrowers to get in over their heads. People could buy homes with no money down and little documentation of their income or assets. Many buyers with weak credit took advantage of low initial rates.

Some housing analysts say the worst is yet to come, partly because adjustable rates may ratchet up sharply.

"Then it's not just people who were teetering on the edge who are going to be in trouble," said Ellen Schloemer, director of research at the Center for Responsible Lending. "I think it's going to be worse than we've seen in the history of the modern mortgage market."

African Americans and Latinos received a disproportionately high number of subprime loans, and "communities of color are going to be hit by this just because of the preponderance of subprime loans in those communities," Schloemer said.

For many borrowers with adjustable rate mortgages, monthly payments can more than double.

Marian Siegel, executive director of Housing Counseling Services in the District, said Washington area borrowers "are just starting to wake up and realize that could soon happen to them."

Siegel said the volume of people seeking counseling from her group dropped significantly in the past few years when it was easy for financially troubled homeowners to sell or refinance. But now, borrowers from all socioeconomic levels are appearing at her doorstep in increasing numbers.

"It has nothing to do with income levels or education levels," Siegel said. "Sometimes we're seeing an inverse relationship, where the more financially sophisticated people thought the world was a rosier place than the less sophisticated people because they were professionals with good jobs who felt secure buying a $700,000 home."

Colin Baird of Northeast Washington lost his job as an information technology specialist in mid-2005 and fell behind on his mortgage payments. He said his lender agreed to suspend his payments for a few months and then tacked on portions of all the payments missed to future ones, along with late fees and other penalties.

Baird considers himself lucky. He found another job and caught up on his loan in August 2006. But it wasn't easy. He had to pay $2,100 a month for a year instead of the usual $1,024.

"In the end, I managed to raise the funds, but it caused me a tremendous amount of pain and suffering," said Baird, who has owned his townhouse since 1990.

Besides borrowers, the parties most at risk tend to be investors who bought securities entitling them to the interest and principal payments on pools of mortgages.

Since the three-month period reflected in the latest Mortgage Bankers Association survey, international mortgage markets have experienced serious shocks and investors have become much less willing to fund jumbo loans. Those developments could exacerbate the situation.

Duncan, the mortgage association economist, predicted that delinquencies will peak next year and that home prices will drop. "We expect for the first time since the Depression that [the] average nominal house price will decline for a full year," Duncan said. The nominal price is not adjusted for inflation.

Much of the trouble can be attributed to second homes and property bought for investment purposes, Duncan said. A separate recent study by the association found that about one in five prime loan defaults in California and one in four in Florida -- both states with high default rates -- involved homes that were not occupied by the owner.

"When you really look at the big picture, you're talking about a pretty small percentage of homeowning households that are in difficulty," Duncan said.