Study: Flood of foreclosures coming

(05/01/2007)
By Holden Lewis • Bankrate.com

You have a one in three chance of losing your house to foreclosure if you got an adjustable-rate mortgage, or ARM, in 2004 through 2006 that had an initial teaser rate of less than 4 percent.
If you got a subprime ARM in that period, you started out with a higher rate, and that puts you at less risk. You have a one in eight chance of losing your home.
That's the takeaway message from a densely detailed research report by Christopher Cagan, director of research and analytics for First American CoreLogic. Cagan's study focuses on 8.4 million ARMs that were originated in 2004, 2005 and 2006. About 1.1 million of those borrowers will lose their homes in the next six to seven years because of payment shock brought on from rate resets or loan recasting, Cagan estimates.
Cagan assumes that property values will remain relatively flat from their December 2006 levels. If house prices fall -- and in many markets, they already have fallen in the first three months of this year -- foreclosures will be higher than his estimates. If house prices rise, there will be fewer foreclosures than forecast. Each 1 percent rise or drop in house prices will translate into roughly a 70,000 decrease or increase in foreclosures.
"These losses are (from) reset only," Cagan says. "I do not study job loss, death, divorce, illness or fraud." For example, the foreclosure rate is high right now in Detroit, but that has little to do with low-rate teaser loans, or subprime ARMs. Job losses are driving foreclosures in Motor City.
Pain will lingerIt's important to remember that Cagan's estimate of 1.1 million foreclosures is forecast to take place over the next six or seven years, not all at once. He says much of the pain will be felt next year and the year after.
"2008 is the pinch year," he says. "That is the pileup of 2/28s originated in 2006 at the peak of the market. And also, you have the 3/27s starting in 2005. Those two years are the peak market years; also very generous lending years, so you had the peak of the market, with people borrowing with nothing down or 5 percent down."

When Cagan talks about the peak of the market, he's talking about house prices. In much of the country, especially along the coasts, prices peaked in 2006. If you borrowed 100 percent or 95 percent of the home's value in 2006, you immediately were under water, owing more than you would get if you immediately sold your house and paid a real estate commission.
Subprime ARMs: 2/28, 3/27Most subprime ARMs are 2/28 mortgages, which start out with an introductory rate that lasts two years, and then are adjusted every six or 12 months thereafter. Subprime 3/27 mortgages have an introductory rate that lasts three years.
A lot of borrowers get 2/28 and 3/27 subprime ARMs with the intention of refinancing in two or three or four years, after they have cleaned up their credit problems. This would allow them to get a better rate. But those who made small down payments will find it difficult or impossible to refinance if their homes have lost value.
Cagan assumes that people will lose their homes if they made small or no down payments and they get caught in the payment-value vise: when their monthly house payments rise to unaffordable levels and the value of the home has dropped or even remained unchanged. Since subprime borrowers start out with relatively higher introductory rates, they won't suffer the worst payment shock.
The biggest payment shocks will be felt by borrowers who got those low-rate introductory loans of less than 4 percent (and, Cagan finds, if you got a teaser rate below 4 percent, it probably was under 2.5 percent -- there weren't many between 2.5 and 4 percent). Their monthly payments can double quickly. About 32 percent of those borrowers will find themselves in the payment-value vise, and will lose their homes, Cagan estimates.
This is the second year in which Cagan estimated how many foreclosures would result from rate reset. A year ago, he forecast that almost $200 billion in foreclosures would result over the next six or seven years. He noted that this would be a problem for borrowers, but not for the economy as a whole.
-- Posted: April 18, 2007

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