The Coming Crunch: How Americans are Increasingly At Risk of Foreclosure

A mental picture of the US housing market: Imagine an elephant riding a child’s bicycle… balanced on a tea cup.

The airwaves and newspaper headlines have been alive with talk of the “sub-prime meltdown” and the tipping point of our housing markets. While recent stories have focused on business issues such as layoffs in the workforce – Countrywide, our nation’s largest home lender is cutting 12,000 jobs – the real problem of the short-term crisis is how quickly and severely a foreclosure crunch could happen to American homeowners.

How Did We Get Here?

It has not always been this way. Thirty years ago, mortgage lending was pretty straightforward. You put down your thirty percent, applied for a loan at your local bank and became a homeowner. However, over time, as our banks become stockbrokers and stockbrokers became banks, the traditional mortgage fell out of style. Bankers started to get clever with lending to help everyone buy a home. The homeownership rate, 55 percent in 1950, rose and then remained around 63 percent from the 1960s to mid-1990s. Since then, the rate has been pushed to almost 69 percent. A good thing, right?

The downside is that bankers looked to lend to more people, even those that had poor credit histories, or were looking to buy a house that was more expensive than might seem prudent. As a result, they invented new kinds of loans to get a borrower into a home (often called “exotic loans”). Because these loans had more risk to them, they were considered part of a new category known as sub-prime mortgages.

A typical sub-prime mortgage is an adjustable rate mortgage (ARM) that allows the borrower to make low monthly payments when interest rates are down, but when interest rates rise, commits borrowers to payments that rise $200, $300, and in some cases, more than $500 a month. In fact, studies show that 32 percent of all mortgages today are ARMs and that perhaps one in five sub-prime borrowers will most likely fall into foreclosure in the coming months.

A recent ACORN report, Foreclosure Exposure showed that there is an epidemic of foreclosures throughout the country. Last year there were 1.2 million foreclosures filed nationwide (that’s over 2 foreclosures every minute). That was a huge increase from 2005 when there were about 900,000 foreclosures filed. The foreclosure problem is expected to get worse this year, with about 1.5 million foreclosure filings nationwide. Foreclosed homeowners could lose up to $164 billion dollars, mostly in lost equity, and as generally lower-income families they can ill afford it.

Predictions for the Future

• Too little, too late: The Fed has taken initial steps to stop the foreclosure crisis by cutting national interest rates by half of a percent (.5%), keeping adjustable rate mortgages lower and making it easier for banks to borrow more money and extend more affordable loans to consumers. However, this will have little effect on falling housing prices, or those homeowners that are on the edge and overextended.

• Don’t you know that they’re toxic? Exotic (some would say toxic) mortgages have multiplied quickly and without regulation in the past few years. For example, the Washington Post reports that just 2 percent of homebuyers in the DC metro area had exotic loans in 2000, but as of last year, over 40 percent of people buying or refinancing had used them. The good news is that many of these loans are slated to disappear in the coming months, especially products like the No Doc/Low Doc or Option ARMs.

• Home prices dropping in the double digits: Experts say it’s going to get worse before it gets better. Since the peak of the housing market in early 2006, national home prices have fallen 6.5 percent and are expected to fall further in the next year with the hardest hit areas (California - Stockton is known as “The Foreclosure Capital”, Florida, the Midwest) decreasing by 10 percent or more.

Bona Fide Bailout or Babysitting: What Should Government, Banks and Lenders Do?

Herein lies the question of advocacy. What is the role of government, banks and others in the housing industry to help consumers navigate this complicated process? Should homebuyers take more responsibility in educating themselves and understanding what they really can afford?

While the Fed has promised to enforce responsible sub-prime lending, more proactive help is needed for at-risk homebuyers ─ a problem that can be easily and directly addressed by lenders. Their first obligation is to appropriately inform their clients about starting a loan they can actually afford. It is their duty to simplify laborious parts of the paperwork, particularly for documents like the disclosure statement. Most consumers never end up reading these because the terms are so vastly confusing. Secondly, for clients already submerged in the mortgage morass, lenders have an even greater responsibility to help modify the existing loan or refinance.

There is widespread disagreement on whether government is doing enough to alleviate consumer suffering. Take, for example, these two contrasting reader comments from CNN.com.

Pro-bailout:
“I am shocked to see how many people have such a problem with this so called ‘bailout.’ While, this may benefit the banks and investors the most, don’t forget your fellow Americans that have been scammed, misled, and taken advantage of by predatory lenders and brokers. These people do deserve assistance and help from losing their “American Dream”. The US gives billions in aid every year to other countries, why is it that we try to short change are fellow Americans with support when they need it? … Perhaps, if the government spent a little more coin on social programs that are easily available to educate the first time home buyer we wouldn’t be having this discussion. Let’s not forget in public schools today we fail to teach our children how to balance a check book or finance a car or house.”

Anti-bailout:
“I am completely opposed to using my tax dollars to bail out mortgage holders that should never have ‘bought’ their homes in the first place. If you can’t afford a house, you can’t afford it. Nothing is more clear. Any attempt at a bailout is just prolonging the inevitable.”