The desire to own a home is almost as American as “baseball, hot dogs, and apple pie.” Perhaps that’s at least one of the reasons why over the past few years, so many people took advantage of lending opportunities with variable rates even though the potential homeowners’ financial resources could be at risk should rates increase.
And, of course, that is what has been happening. Many of those who acquired subprime mortgages have defaulted and suffered foreclosure; some have even declared bankruptcy because of their inability to make the increased payments required.
The Mortgage Bankers Association recently indicated that in the third quarter of this year, the foreclosure rate jumped to 0.78%, a record high, and that the delinquency rate for all mortgages rose to 5.59%, the highest level in two decades. Seventeen of the top 25 metro area foreclosure rates are in cities in California, Florida, and Ohio. Borrowers in the Lone Star State, even those with subprime loans, are not facing difficulties as severe as homeowners in those and many other states. Home prices are continuing to climb in Texas, thereby aiding to a significant degree those planning to sell or refinance. However, like everyone else, Texans are finding it more difficult to get a mortgage and are seeing some slowdown in the residential market.
The housing difficulties began to surface in late 2005 and 2006 near the end of the nationwide housing boom. To get in on the rising opportunities, many lenders had allowed borrowers to take out no-documentation loans or to obtain funds based on inflated annual incomes. As the variable rates eventually increased, so did the mortgage defaults, causing billions of dollars in losses for major banks, hedge funds, and other investors. The domino effect rumbled across financial markets worldwide.
Nearly eight out of every 10 mortgages in the US are prime (for borrowers with good credit) while approximately 14% are subprime (individuals deemed less creditworthy because of low credit scores or unstable income prospects). Another 6% fall into the near-prime category (those who are unable to fully document income or make traditional down payments).
While the picture painted by those numbers does not look too bad, it’s not complete. To understand the current situation, it is important to note that subprime and near-prime loans have increased from 9% of new mortgages in 2001 to 40% last year.
Because of the unusual difficulties posed by these occurrences, a national mortgage-rescue plan for troubled homeowners has been authorized by the President. The plan temporarily freezes the rates of some homeowners who are likely to face a hike in their adjustable-rate mortgages next year. Others would receive assistance in refinancing with their lenders or in obtaining funds secured by the Federal Housing Administration. The plan is also designed to help state and local governments issue tax-exempt bonds to pay for mortgage refinancing.
For those eligible for the freeze, the plan puts a hold on interest rates for many subprime mortgages (loans granted to those with poor credit histories) at the present level and prevents them from resetting to higher rates for five years. Loans obtained in this manner could have been reset upwards of 4 percentage points, thereby adding hundreds of dollars to typical monthly payments, a cost many families cannot afford.
Last week, when President Bush announced the freezing of interest rates for selected individuals, he noted that the plan was a voluntary, private-sector arrangement and was not intended to violate normal free-market operations. He further emphasized that no government funds would be involved to bail out lenders or speculators or even those who borrowed more money than they knew they might be able to repay. Rather, the key purpose of the arrangement was to prevent massive foreclosures that could cause a strain on the nation’s economy.
The hope is that over the next five years, the economy will improve sufficiently and that a housing rebound would enable homeowners to refinance their adjustable rate mortgages with fixed-rate loans. It remains to be seen how it will work in practice.
There have been some voices declaring that the President’s unprecedented plan does not go far enough or cover a sufficient number of those in financial difficulty. Even so, it is evident that the move can have a positive impact on the nation’s fractured housing market, though it will frustrate many bond investors. Not only will thousands of homeowners receive a temporary helping hand, but lenders and investors also stand to benefit with mortgages that are being paid compared to foreclosed loans. Overly zealous markets produce these kinds of situations from time to time. When they occur, we basically muddle through until our resourceful economy works its magic. This program may help the muddling just a bit.