While some of the nation’s leading economists are optimistic for an improved housing outlook during the second half of 2007, Wall Street’s capital markets researchers — the money guys — are concerned hundreds of thousands of home loan borrowers could be in default before the summer months arrive.
Chris Flanagan, managing director and head of global research for JP Morgan Securities, said approximately 35 percent of all subprime mortgage borrowers could have a difficult time meeting their loan obligations when their adjustable-rate mortgages hit their first adjustment period.
“These are consumers who were getting into 100 percent loans when home prices were softening,” Flanagan said. “The more troubling characteristic were the lenders willing to reach to make those mortgages available.”
Flanagan’s research revealed that 10 percent to 15 percent of all new loans originated in the fourth quarter of 2005 and all of 2006 were subprime loans — mortgages that typically carry higher interest rates due to greater borrower risk. And, if capital market players like JP Morgan find mortgage securities no longer attractive, the result could be higher mortgage interest rates.
The amount of money at stake could be $200 billion, with as many as 500,000 to 1 million consumers in potential jeopardy. Many of the loans were “stated income” or low-documentation loans, which involved a relatively low-interest-rate first mortgage and a simultaneous, or “silent second,” mortgage, which together equaled the entire value of the property. In the mortgage business, this is known as a 100 percent loan-to-value-ratio loan.
Frank Nothaft, chief economist for mortgage giant Freddie Mac, said while subprime borrowers typically have a default rate eight to 10 times greater than conforming borrowers, he was more suspicious of the huge share of speculators/investors than owner-occupants.
“For an owner-occupant to go into default, you usually have to have a trigger event like unemployment or serious illness in the family,” Nothaft said.
Leslie Appleton-Young, chief economist for the California Association of Realtors, said many buyers in Los Angeles County “were underwater” with their loan payments in 1992 but managed to find a way to stay in the home and accrue the amazing appreciation of the past 10 years. Last year, when home prices softened, many potential buyers lost the “psychological impetus” to get into the market.
“During the boom, houses in some neighborhoods were going up 20 percent,” Appleton-Young said. “Consumers could not afford not to buy. But when that that appreciation factor goes away, psychologically they are not in the same place.”
The manufacturing sector has continued to suffer. Delinquencies and foreclosures have increased in low-employment regions like Michigan, Indiana, Kentucky, Virginia and Ohio. Of the 1.8 million jobs created last year, not one of them was in Michigan, according to Nothaft.
Banking regulators have scrutinized low-down-payment mortgages for the past two years yet lenders have not significantly curtailed “exotic” programs. The subject often fuels the controversial question if lenders have gone too far in extending credit to consumers — or have they simply helped borrowers get in to markets unattainable with a conventional loan. Nothaft believes that while exotic mortgages have a place and serve a specific niche, many borrowers who should not be approved for them get them anyway.
Nothaft predicted that 30-year fixed-rate loans would rise a tick during the second half of 2007 — averaging 6.3 percent, up from 6.2 percent — but that 2007 would in no way resemble the boom times of 2005.
“Home sales were down 18 percent in 2006 from 2005 and I don’t think we are at the bottom of the trough yet in 2007,” Nothaft said. “What limited the affordability was that both interest rates and home prices rose at the same time. We are not going to see that later this year, and we should also have stable family income.”
Susan Wachter, professor of real estate and finance at the University of Pennsylvania’s Wharton School, was not as optimistic as Nofthaft about the 2007 outlook. Not only was the first half of the year “in the bag” but also the second half was “more in question” and the year as a whole could resemble a repeat of 2006.
“The first half will have high inventories in a lot of areas but the second leg of this thing is that home equity has been supporting this economy,” Wachter said. “That isn’t going to be there this year because consumers have already taken it out of their homes. As prices decline, I think there could be a downside risk, especially if inflation begins to move higher.”
Tom Kelly’s book “Cashing In on a Second Home in Mexico: How to Buy, Rent and Profit from Property South of the Border” was written with Mitch Creekmore, senior vice president of Houston-based Stewart International. The book is available in retail stores, on Amazon.com and on tomkelly.com. Tom can be reached at firstname.lastname@example.org.