By
JAMES R. HAGERTY
March 11, 2006; Page A1
Millions of Americans who stretched themselves financially to buy homes face a painful adjustment -- some could even lose their houses -- as monthly payments on adjustable-rate mortgages are reset higher.
In the hot housing market of recent years, many households took advantage of "affordability" mortgage loans -- heavily promoted by lenders -- that hold down payments for an initial period. Now the initial periods are coming to an end on many of these loans, leaving borrowers to face resets of their interest rates that can cause monthly payments to shoot up between 10% and 50%.
More than $2 trillion of U.S. mortgage debt, or about a quarter of all mortgage loans outstanding, comes up for interest-rate resets in 2006 and 2007, estimates Moody's Economy.com, a research firm in West Chester, Pa.
Most borrowers will be able to cope with the coming wave of resets, in some cases by refinancing with new loans, lenders and mortgage industry analysts say. But some borrowers will have trouble meeting the higher payments and may be forced to sell their homes or could lose their homes to foreclosures. A recent study by First American Real Estate Solutions, a unit of title insurer First American Corp., projects that about one in eight households with adjustable-rate mortgages that originated in 2004 and 2005 will default on those loans.
Resets will "eat into discretionary spending" for many Americans, says Joshua Shapiro, chief U.S. economist at MFR Inc., an economic consulting firm in New York. He expects consumer spending to slow in the months ahead but says the job market remains strong enough to keep most people out of serious trouble.
Still, a barrage of negative trends is making things tougher for already-strained borrowers. Interest rates are rising, which can increase the size of each mortgage reset and make refinancing more expensive. The housing market is cooling, making it harder to sell homes or build up a cushion of home equity.
Regulators are pressing lenders to tighten their lending standards, which probably will make it more difficult for some people to qualify for refinancing. And some credit-card companies have recently started requiring higher minimum payments. Energy costs are up sharply, too, as are property taxes.
One couple that faces a reset this summer is Ruth and Magdi Fadlalla, who two years ago bought a three-bedroom house for about $294,000 in the New York borough of Queens. Their loan carries an interest rate of 7.46% for the first two years. This summer, at the first reset, the rate will jump to 9.46%, they have been advised, and the rate could rise further in the future unless interest rates generally decline. Already, the Fadlallas have fallen behind on their monthly payments of about $1,950 and have been put on notice that their home could soon be lost to foreclosure.
'This Is Killing Me'
Mrs. Fadlalla, a special-education teacher, says her property taxes have risen sharply and other costs of home ownership proved higher than she expected. "This is killing me," Mrs. Fadlalla says, though she adds that "I'm going to work it out."
She is working with two local nonprofit groups, Neighborhood Housing Services of New York and Jamaica Housing Improvement, to try to avert foreclosure. "They never could afford this loan," says Peggy Morris, executive director of Jamaica Housing Improvement, who blames lenders for failing to take more care in warning borrowers of risks.
The Fadlallas got their loan through a branch of Southern Star Mortgage Corp., East Meadow, N.Y., acting as a broker. Like most mortgages, the loan later was sold to a financial firm that put it into a pool of loans that back mortgage securities owned by a variety of investors. Gary Shusterhoff, president of Southern Star, says the Fadlallas qualified for the loan when they applied.
A unit of
Wells Fargo & Co., acting as a trustee for the investors that now own the loan, has initiated legal action to collect overdue payments. A Wells Fargo spokeswoman confirmed the action but had no further comment.
Debt counselors are bracing for many more such cases. "We have just begun to see what I fear is going to be quite a flood" of people seeking help in coping with resets, says Sarah Gerecke, chief executive of Neighborhood Housing Services.
Christopher L. Cagan, director of research and analytics at First American Real Estate Solutions, Santa Ana, Calif., plays down the threat to the economy as a whole from resets. He figures most borrowers who bought their homes or most recently refinanced before 2004 are in good shape. That's because the surge of home prices in most parts of the country lifted the values of their houses well above the amounts due on loans.
The bigger risk is with people who bought homes more recently and haven't yet benefited from lots of price appreciation -- and, in some cases, won't necessarily benefit at all because their local markets are cooling. For a study released in February, Dr. Cagan examined adjustable-rate first mortgage loans made in 2004 and 2005, including refinancings. He figures about 7.7 million of these loans are outstanding, representing $1.888 trillion of debt.
About 1.4 million of those households face a jump of 50% or more in their monthly payments once their initial low-payment periods run out, Dr. Cagan says, and an additional 1.6 million face smaller increases that are still likely to strain their finances.
Assuming that home prices stay around current levels and interest rates don't rise sharply, Dr. Cagan figures about one million households eventually will default and lose their homes to foreclosure. That would cause about $110 billion of losses for lenders, he says.
Lenders and the economy as a whole could easily cope with such losses, Dr. Cagan says, though it would be devastating for some families and painful for some investors who bought securities backed by the riskiest loans. "It won't happen all at once," Dr. Cagan says. "It will be spread out over several years."
Such wild cards as interest rates and home prices could throw off the projection. If interest rates shoot upward and home prices fall, the number of foreclosures could be much higher than Dr. Cagan's scenario foresees. If interest rates decline and home prices surge, the damage would be less.
Assuming economic growth remains healthy, foreclosures are likely to increase only "modestly" from the current pace, says Doug Duncan, chief economist at the Mortgage Bankers Association. He says job losses -- not resets -- are the biggest cause of foreclosures.
Subprime borrowers, those with weak credit records, are most at risk. In the past few years, many subprime borrowers held down their initial costs by using so-called 2/28 loans, whose rates are fixed at a relatively attractive rate for the first two years.
A typical subprime borrower who took out a 2/28 mortgage in 2004 has been paying interest of 7.1% for the first two years, says Grant Bailey, a director at Fitch Ratings in New York. Once that introductory period ends, the interest rate is reset every six months for the remaining 28 years of the loan at a margin over interbank rates, the rates banks charge one another for short-term money.
The 2/28 loans generally limit the size of the first jump in rates to around three percentage points. That would bring the monthly rate to 10.1%. Monthly payments for a borrower with a loan of about $150,000 would rise to about $1,315 from $1,000. Assuming interest rates stay around current levels, the rate would jump again to about 11% within six months to a year, bringing the monthly payment to $1,400, or 40% higher than the initial payment. Borrowers who chose loans that allow them to pay only the interest for an initial period, deferring principal payments, face even bigger increases -- more than 50% in some cases.
Choosing to Refinance
Rather than face those big jumps, many borrowers will refinance into new 2/28 loans, Mr. Bailey believes. Currently, they could get an initial rate of about 8% to 8.5% on a new loan.
But that won't be possible for some borrowers who have taken on lots more credit-card debt and whose homes haven't appreciated as much as expected. Because their debt costs would be so high in relation to their income and because they can't extract cash from their home equity, they may not qualify for refinancing. That means meeting the higher payments on the original loan or facing foreclosure.
"The ones who get stuck are probably going to be the ones who needed to refinance the most," Mr. Bailey says.
Even those who do refinance into a new 2/28 loan won't necessarily be in the clear because they still face an eventual reset, and refinancing typically costs thousands of dollars in fees, which often are rolled into the new loan.
A common sales pitch for 2/28 loans is that the borrower can use those first two years before the reset to improve his or her credit score and then qualify for a cheaper prime loan. "But that goal is rarely realized," says Daniel H. Jacobs, chief executive officer of 1st Metropolitan Mortgage, Charlotte, N.C. As the housing market cools, it probably will get harder for marginal borrowers to refinance on attractive terms, he notes, adding: "At some point, people are going to have to pay the piper."
