The Bottom Line: Foreclosures pinch American dream

U.S. home foreclosures increased 19 percent in January 2007, up 25 percent from January 2006. That’s according to the newest report from RealtyTrac, the foreclosure data provider to MSN Real Estate, Yahoo! Real Estate and The Wall Street Journal’s Real Estate Journal.

            “January’s foreclosure number represented the highest monthly number we’ve seen since we began issuing this report two years ago,” says RealtyTrac CEO James Saccacio in a company release.

            In all, 1.2 million homes were foreclosed on in the U.S. in 2006. That’s a 42 percent year-over-year increase from 2005. In some areas, such as Memphis, the number of foreclosures is neck and neck with the number of homes sold.

            Though these statistics are shocking, it bears mention that roughly 14 of the past 24 years had foreclosure rates that were just as high or higher. For details see the “Mortgage Delinquency Rate” chart, which first appeared in a report from Jay Brinkmann, vice president of research and economics for the Mortgage Bankers Association.

            I struggle to make sense of these statistics. Home ownership is the quintessential American dream, nearly a protected right thanks to generous lending practices and low-income home buyer assistance programs. Yet with each new year, January marks the grimmest month for homeowner dreams. Historically January sees up to 27 percent spikes in foreclosures as mortgage companies move in to repossess the homes where people aren’t able to keep up on monthly payments.

            Why January? It takes four months from the time a homeowner defaults to the time they lose their house. Hence, the bulk of defaults start in October. This coincides with the launch of the Halloween/Thanksgiving/Christmas “holiday season” – a period of rampant consumerism that is uniquely American.

            Why so many? The number of foreclosures is relative to the number of consumers that either 1) fail to keep current on mortgage payments or 2) fail to pay property taxes. Industry observers like Saccacio blame 2006’s numbers on “the impact of monthly mortgage payments increasing dramatically for homeowners who held some of the riskier types of adjustable rate and sub-prime mortgages.”

            Sub-prime lenders approve loans based only on the borrower’s ability to repay the cost of principal and interest. These loans don’t consider the homeowners’ ability to also pay property taxes, homeowner’s insurance and other living expenses. With mortgage payments that don’t leave enough room for paying these other expenses, it’s easy to see how borrowers could soon be cash-strapped.

            The first comprehensive and nationwide review of these loans was conducted December 2006 by the Center for Responsible Lending, a nonprofit research and policy organization based in North Carolina. The study reviewed millions of sub-prime mortgages originated from 1998 through 2004, and made some projections based on its findings.

            The bottom line? The Center projects that one out of five (19.4 percent) sub-prime loans issued in the past two years will end in foreclosure.

            “[A]djustable rates, prepayment penalties and limited income documentation [all] increase the risk of foreclosure significantly,” states Center President Michael Calhoun. “In fact, our study shows that the risk on an ARM versus a fixed-rate mortgage is 72 percent higher.  That's an increased risk regardless of the borrower's credit.”

            Other experts warn that homeowners counting on continued double-digit property value increases – to refinance to pay off their debts or sell their home at a profit – may soon run into similar trouble. The Center for Responsible Lending backs up this warning with these findings: “Our study also finds that recent high appreciation in many areas has masked problems in the sub-prime market, and that the cooling housing market will cause failure rates to rise sharply in many major markets. California, Arizona, Nevada, and greater Washington D.C. will be especially hard hit.”

            What can be done about this? One of the largest investors in mortgages,

Freddie Mac, is setting the pace. This stockholder-owned corporation — chartered by Congress in 1970 to buy real estate loans from mortgage companies — announced on Feb. 27 that it would no longer buy sub-prime adjustable rate mortgages that do not qualify borrowers at the “fully-indexed and fully-amortizing rate.”

            So what does this mean for my local home market? “It’s true that foreclosures could have a negative impact on the housing market if they continue to increase at this rate, and in some of the more problematic local markets they already may be contributing to slowing home price appreciation and a glut of homes for sale” Saccacio says. “However, most local markets have been able to re-absorb foreclosure homes without seeing any major damage to the local economy.”

            The bottom line results, however, remain to be seen.

 "The Bottom Line" by Gather Correspondent Jennifer D. Meacham is published every Wednesday to Gather Essentials: Money. Jennifer also covers business/personal finance for The Oregonian newspaper and real estate news for RISMedia, and co-authored the best-selling retirement investing guide "IRA Wealth: Revolutionary IRA Strategies for Real Estate Investment" (Square One Publishers, New York).  Keep up on the latest news and analysis into how you can take control of your business and personal financial future by joining Jennifer's Gather network(select the orange “Connect” button on the left of the page). You’ll find Jennifer and other Money Correspondents, plus celebrity content and plenty of other money experts, at Money.gather.com.

Subscribe to Gather.com today to make a comment on this article.