Good News About the Sub-prime Mortgage Crisis

By: Lloyd Segal

Hey, wait a minute! In recent months, the national media has dwelled on the collapse of the subprime mortgage market and the surge of foreclosures. But there is another side to this story that should also be considered.

The Mortgage Bankers Association recently released its National Delinquency Survey and the numbers are not what you may think. True, the rate of loans falling into foreclosure last quarter was the highest in the survey's 54-year history. 8.4% of subprime loans were more than 90 days late or already in the foreclosure process. That statistic is sobering, but it misses the point. If 8.4% are seriously delinquent or in foreclosure, 91.6% of the sub-prime borrowers are current with their loans and making their mortgage payments on time. They are enjoying the benefits of home ownership. Those borrowers were given the opportunity to own (rather than rent) because of the availability of sub-prime loans and have successfully taken advantage of that opportunity. For them, the "American Dream" has become a reality.

Of course, 8.4% default rate is high, but unanticipated financial problems happen. After all, people don't buy homes, take out loans, and then intentionally default. Usually something serious happens to disrupt the natural process. Commonly, it is loss of job, divorce, medical catastrophe, or some other unanticipated financial emergency that causes people to default. Keep in mind, though, you don't have to a sub-prime borrower to have financial problems. Prime borrowers also default on their loans and lose their homes in foreclosure (no one is immune in this market). Sure, the percentages are higher for sub-prime borrowers, but they are typically in a more vulnerable financial situation. Of course, they have a higher interest rate and pay a larger mortgage payments every month, so cut them some slack. Regardless, the solution is not to cut-off subprime lending, but rather to embrace these borrowers' unique needs. Particularly now, lenders need to offer delinquent homeowners programs to restructure their loans and avoid foreclosure. Let' look at why.

Delving deeper into the MBA survey, we discover several surprising facts. For example, the surge in sub-prime foreclosures last quarter was driven by four large states, California, Arizona, Nevada, and Florida. If it were not for the avalanche of foreclosures in those four states, there would have been an overall drop in the rate of foreclosure filings nationwide. Thirty-four states actually reported a decrease in the rate of new foreclosure foreclosures in the last quarter, and the remaining states (other than those four) reported only a modest increase.

There is also a wide divergence between fixed-rate and adjustable-rate loans. The delinquency rate for prime fixed-rate loans was essentially unchanged from the previous quarter and the rate for sub-prime fixed rate loans actually fell! In contrast, the rate of delinquency for prime adjustable-rate mortgages increased 36% and sub-prime adjustable-rate mortgages increased 227%.

Clearly, adjustable-rate mortgages ("ARMs") are the culprit and present a unique problem. But there is nothing wrong with ARMS, provided they are utilized responsibly. They have benefits you can't find with fixed-rate loans. They have lower interest rates and correspondingly lower monthly payments. They allow borrowers to qualify for loans they would not otherwise receive (of which the vast majority successfully pay each month). Plus, it just doesn't make sense to obtain a 30-year fixed rate loan, when in reality most people sell or refinance their homes every 5-7 years.

Nationwide, California leads the way with over 17% of all sub-prime adjustable rate mortgages. Similarly, California has over 19% of the foreclosures for sub-prime ARM loans. In fact, the same four culprits; California, Nevada, Arizona and Florida, have more than one-third of the nation's sub-prime ARMs, more than one-third of the foreclosures started on sub-prime ARMs, and most of the nationwide increase in foreclosures.

Another factor to consider is the distinction between owner-occupied and investor (non-owner occupied) borrowers. A majority of the delinquencies and foreclosure starts can be attributed directly to non-owner occupied loans. This is because investors are notorious for defaulting on mortgages when the market dips and they see the value of their properties evaporating. Further exacerbating the problem, investors' share of defaulted loans was 32% in Nevada, 25% in Florida, 26% in Arizona, and 21% in California. Yep, those same four states. Those rates are high compared with a rate of only 13% for the remainder of the country. And those percentages will certainly increase as property values continue to decline.

One more thing. The media has been quick to blame mortgage brokers for "forcing" borrowers into sub-prime adjustable-rate loans. I laugh every time I hear that. Anyone who has ever been a mortgage broker knows that you can't force a loan on borrowers, prime or sub-prime. It doesn't work like that anymore. Homeowners are more sophisticated than ever before. They have access to the internet, television and the mass media, and analyze available loan programs. They understand the difference between fixed-rate and adjustable-rate loans, between amortized and interest-only payments, and between "stated" and full documentation. They shop and explore alternatives. Ultimately, they select the loan they want, not their mortgage broker. Regardless of what the media says, that process works successfully for the vast majority of American homeowners.

All tolled, the sub-prime mortgage crisis is bad, but not nearly as bad as the media would have you believe. If you dig deeper into the survey, and segregate the four problem states, subprime ARMs, and investor loans, you will discover that with the vast majority of American homeowners, default and foreclosure are not issues. At least not yet.

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