Foreclosures used to be a rarity and for the most part that's still the case. Only about 1 percent of all loans are now in the process of being foreclosed, according to the Mortgage Bankers Association.
That term "in the process of being foreclosed" is important. Neither borrowers nor lenders benefit from foreclosures. For borrowers the loss of a home is a personal tragedy as well as a huge credit stain that will impact finances for years. For lenders, foreclosures suggest losses, legal bills, vanished interest, unrecovered principal and lots of explaining to regulators.
The result is that a large percentage of homes which are "in the process of being foreclosed" are never actually foreclosed. The property is sold before the foreclosure, the loan is re-worked, the property is refinanced or back payments bring the loan current and the matter is resolved with as little damage as possible to both lenders and borrowers.
But new figures from RealtyTrac, an online foreclosure marketplace that covers some 2,500 counties nationwide, show that in March 2006 the number of homes entering the foreclosure process increased by 323,102 properties. That's 72 percent higher than a year earlier.
Eternal optimists may say this is good news for those who deal in foreclosures. But while foreclosure clean-up is necessary, if there's an increased number foreclosures in your neighborhood and properties begin to sell at low values, guess what happens to local home prices? Guess what happens to the value of your home?
RealtyTrac -- which has more than 600,000 pre-foreclosure and foreclosure properties in its database -- reports that Georgia had the nation's highest foreclosure rate with one new foreclosure for every 127 households in the first quarter -- up almost three times from a year earlier. Quarter to quarter, foreclosures were up 96 percent in Colorado and 84 percent in Indiana.
You have to wonder: Are we seeing more foreclosures than last year as toxic mortgages mature? These are "nontraditional loans," a sterile description for mortgages with ridiculously low monthly costs at first (but higher costs later) as well as mortgages that feature limited documentation and overly-large initial loan balances. Specifically, we're talking about option ARMs ( Home Water Heaters Hot Water Heater Tank Heated Water System ), interest-only loans , stated-income financing and super-jumbo mortgages .
We asked Rick Sharga, Realty Trac's vice president of marketing, about the impact of toxic loans on the rising number of foreclosures and here's what he had to say:
Question: Are toxic loans linked to the rise of foreclosures?
Answer: While we haven't seen any report that definitively links the two, it's logical to surmise that higher risk loans will default at a higher rate than more traditional loans. And the fact that a larger percentage of home loans fall into the high risk category than at any time in recent memory makes the possibility of a spike in foreclosures more likely.
Question: Have toxic loans begun to impact the marketplace?
Answer: It's hard to assign the increase in the number of properties in default and foreclosure specifically to high risk loans, but they're almost certainly a contributing factor. As large numbers of ARMs reset this year and next -- we've seen numbers as high as $300 million in loans this year and $1 billion in 2007 resetting -- we'll be better able to gauge the impact on national foreclosure rates.
Question: Will we see a further increase in foreclosure levels?
Answer: We anticipate that foreclosures will increase throughout 2006 for several reasons.
First, the number of properties in foreclosure has been below historic averages for several years, and the market appears to be moving back toward more "normal" levels.
Second, increasing interest rates are driving up monthly payments for homeowners with ARMs, and will significantly increase monthly payments for people with 3/1 or 5/1 ARMs due to reset.
Third, house values appear to be cooling off, which gives homeowners less equity to leverage in the event that they find themselves in a financial bind -- and limits the opportunity to sell a property at a profit for homeowners in default.
There are ancillary economic factors that also come into play. Rising interest rates have had an effect on monthly credit card payments in an economy with a very high amount of consumer credit card debt.
Energy costs have risen faster than anticipated. In some parts of the country, major employers such as Ford and GM have announced plans for massive layoffs, and there tends to be a strong correlation between higher-than-average unemployment rates and higher-than-average foreclosure rates.
Question: How long will it take to clean out weak borrowers?
Answer: It's almost impossible to answer that question because there are so many factors involved, ranging from house appreciation rates to rising and falling interest rates to supply and demand within any given market to how far lenders are willing to extend themselves to "save" a troubled loan and even to the overall strength of the economy.
Question: Any general industry comments?
Answer: One of the trends we're following is the number of properties that actually end up becoming REOs (bank repossessions). Over the past year, even as the general numbers of properties entering foreclosures has increased, the number of homes that actually end up as REOs has consistently stayed below 20 percent of the inventory. That relatively low number suggests that the market has been strong enough to allow owners to either re-finance, work out new terms with lenders, or sell the properties before they're foreclosed on. It's a statistic we'll be watching closely, as we believe that a spike in the percentage would be a red flag.
The other statistic we've been tracking is the sales price of properties in foreclosure relative to estimated market value of the properties. In "hot" markets like CA, foreclosure properties have retained 80- to 88-percent of full market value over the past six months, whereas in other areas the numbers have been significantly softer (Minnesota, for example, was just below 50 percent). These relative prices also bear watching as a dramatically lower price combined with a high number of foreclosure properties could have a definite impact on home prices in a given area.
What we may be seeing is the coming together of slowing local markets at the very same time that large numbers of borrowers are facing stiffly higher payments. This combination of events will surely test those who believed that rising home values were assured, certain and guaranteed; an easy escape valve if monthly payments could not be met.