Who'll rescue homeowners in the housing mess?

By Jim Jubak

Banks to customers: Drop dead!!

Nobody in the financial industry is saying that in so many words. But their actions speak volumes. While bankers have plenty of time to negotiate the terms of an $80 billion fund to rescue their own mortgage portfolios, customers are getting a busy signal if they want to fix a problem mortgage before it explodes into foreclosure or bankruptcy.

According to a Moody's (MCO, news, msgs) survey of the mortgage companies that service about 80% of all subprime mortgages, lenders have eased terms on just 1% of the subprime mortgage loans that reset to higher interest rates in January, April and July of this year. That's a huge problem, again according to Moody's, because data indicate that between 5% and 15% of subprime loans that are current before they reset will go into default after reset they if they are not modified.

And this is before the mortgage resets really hit the fan. Adjustable mortgage resets are projected to hit $55 billion in October, up from $22 billion in January, and then continue to climb until the market hits a peak of $110 billion in adjustable mortgage resets in March 2008.

A deluge of foreclosures

In other words, without some kind of modification of the terms, we're about to see an explosion of delinquency and foreclosure rates for subprime mortgages far above the 10% rate during the housing market's boom years. And the mortgage industry is doing almost nothing to head off the problems.

Nobody disputes that homeowners with less than sterling credit -- the so called subprime and Alt-A segments of the mortgage market -- who used adjustable-rate mortgages to finance the purchase of a house over the past year or two face a crisis. Many of these mortgages are about to reset, from low teaser interest rates and monthly payments to much higher rates and payments.

Look at how that works on a 2/28 mortgage, one of the most common types of adjustable subprime mortgages, with interest-only payments -- no payments to reduce principal -- over the first two years. With a low 5.375% teaser interest rate and the interest-only feature, payments on a $300,000 30-year loan would be $1,344 a month for the first two years.

But then at the end of two years comes the reset -- often 2 percentage points or even 3 percentage points annually. With a two-point reset and the expiration of the interest-only period, the interest rate jumps to 7.375% and monthly payments rise $769 to $2,113. That's a 57% increase. The next year, the reset could take the interest rate up to 9.375% and the monthly payment to $2,549, an increase of $1,205, or 90%, in two years.

Who's to blame?

And because these loans were so often used to shoehorn buyers into more house than they could actually afford with a conventional mortgage, that kind of increase is more than enough to produce delinquency and then foreclosure.

The Mortgage Bankers Association reported that as of December 2006, delinquency rates for prime mortgages remain near their historical rate since the early 1990s of 2% (for fixed loans) and 4% (for adjustable loans). But in that same month, 14% of adjustable subprime mortgages were delinquent.

Why did these borrowers get into this mess? Some were greedy, figuring that a rising real-estate market would let them sell the property before the mortgage reset. Some were overly optimistic, hoping that home prices would keep rising and that they could refinance before the reset hit. Some were foolish and didn't do the math for the years after the reset.

(Never underestimate good old time-honored human stupidity. According to a recent survey by Peter D. Hart Research Associates for the AFL-CIO, about 75% of borrowers didn't have a clue about how much their payments would climb after a reset.)

And some were defrauded by mortgage lenders and mortgage brokers who guaranteed that house values would climb and refinancing was a lock, and then hid extra costs and the full size of the monthly payment from those signing on the bottom line.

The industry has changed

Traditionally, though, the debt markets don't care why a deal has gone bad. The saved and the damned are all offered a chance to work out a deal. It's simply good business. Better to get 70 cents on the dollar than 60 cents; better to slow down payment increases so the borrower doesn't go into default; better to take a slightly lower monthly payment than to have to go to the expense of foreclosing and reselling.

So, for example, mortgage lenders could extend initial teaser rates for a year or three, or stretch out the reset by setting a lower annual cap to interest-rate increases, say one percentage point a year instead of 2 or 3 percentage points. Mortgage lenders would still get paid -- less than if they didn't modify the loans, it's true, but more than if borrowers go into default and then foreclosure.

Continued: Why the industry has been slow to act

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