The foreclosure crisis will “get worse before it gets better,” but just how bad depends on how far house prices fall, the president of the Federal Reserve Bank of Boston said today.
In a speech based on a new study of subprime lending in Massachusetts, Boston Fed chief Eric Rosengren encouraged lenders to extend the loan terms of qualified borrowers facing interest rate resets or help them refinance into fixed-rate loans.
Rising home prices and “abundant” financing helped 71 percent of subprime borrowers who took out 2/28 adjustable-rate mortgage (ARM) loans in 2004 to “retire” them by refinancing them before their interest rates reset, Rosengren said.
The percentage was even higher in New England, Rosengren said, where 74 percent of subprime 2/28 ARM loans were retired in two years, and 93 percent in three years. By contrast, 12.4 percent of subprime ARM loans are seriously delinquent today.
The problem isn’t so much that the loans reset to higher interest rates, Rosengren maintains — the average “teaser” rate on a 2/28 subprime loan made in 2006 was a “not particularly low” 8.5 percent — but that many borrowers simply can’t refinance as planned.
Eight out of the top 10 subprime lenders in Massachusetts are no longer operating, Rosengren said, and home prices aren’t appreciating the way they were during the boom, making it harder to refinance a loan.
House price appreciation plays “a dominant role” in generating foreclosures, according to a study released today by the Federal Reserve Bank of Boston, “Subprime Outcomes: Risky Mortgages, Homeownership Experiences, and Foreclosures.”
Homeowners who have suffered a 20 percent or greater fall in house prices are roughly 14 times more likely to default on a mortgage compared to homeowners who have enjoyed a 20 percent increase, the study found.
“We attribute most of the dramatic rise in foreclosures in 2006 and 2007 in Massachusetts to the decline in house prices that began in the summer of 2005,” the study concluded. While subprime lending played a role, the role was “in creating a class of homeowners who were particularly sensitive to declining house price appreciation, rather than, as is commonly believed, by placing people in inherently problematic mortgages.”
The study, of the Massachusetts housing market from 1989 to 2007, found homes originally purchased with a subprime purchase mortgage ended up in foreclosure about 18 percent of the time, or more than six times as often as those purchased with prime purchase mortgages
About 30 percent of foreclosures in the state during 2006 and 2007 were traced to homeowners who used a subprime mortgage to purchase their house.
A higher percentage — almost 44 percent of foreclosures — were on homes whose last mortgage was originated by a subprime lender. About six out of 10 of those borrowers had originally purchased their home with a prime mortgage, and then refinanced into a subprime mortgage.
The result “implies that a large factor in the crisis stemmed from borrowers who began their home ownership with a prime mortgage, but subsequently refinanced into a subprime mortgage,” the study said.
That’s a finding with implications in the debate over the regulation of the subprime market, the study said.
Rosengren said another lesson of the study is that many subprime borrowers may qualify for prime loans or loan guarantee programs like those offered by the Federal Housing Administration.
The Boston Fed’s study suggested that nationally, 20 percent of subprime loans were full documentation loans on owner-occupied properties with loan-to-value ratios below 90 percent and FICO scores above 620.
“Banks may not have viewed this market as an engaging opportunity when mortgage brokers were going aggressively after the business, but banks may now find profitable lending opportunities in the current environment – perhaps, in some cases, with guarantees provided by Federal Housing Administration (FHA) loan guarantees, or state programs,” Rosengren said.
Treasury Secretary Henry Paulson today said that the Bush administration is proposing that state and local governments be allowed to temporarily broaden tax-exempt bond programs to include mortgage refinancings. Current law allows states and localities to issue tax-exempt bonds only to assist first time homebuyers or homebuyers in designated “distressed areas.”
Some state housing agencies have launched pilot programs that rely on taxable bond issues to refinance subprime borrowers into more affordable mortgages.
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