A Reckoning With Risk
Will adjustable-rate loans lead to record foreclosures?
Call it the worst worst-case scenario.
The interest rate on your adjustable-rate mortgage jumps just as the housing market enters a prolonged slump.
Then something really bad happens: You lose your job. There's a medical emergency. You get divorced. You fall behind on your mortgage payments, and the bank forecloses on your home.
Those scenarios are now playing out for growing numbers of homeowners. Nearly 90,000 homes entered foreclosure in June, about a 17 percent increase over a year ago, according to RealtyTrac. Especially hard hit are homeowners in Massachusetts, where foreclosure filings jumped 66 percent in the second quarter as the housing market continued a sharp downturn. Foreclosure rates could increase more over the next year or so, "especially if we end up in a recession and see a lot of job loss," says Doug Duncan, chief economist with the Mortgage Bankers Association.
Warning. In the past, foreclosures have largely been the result of a bad economy. Yet this time around, with a record number of borrowers exposed to rising mortgage payments through adjustable-rate and subprime mortgages, the increase in foreclosures could be a bad omen.
Adjustable-rate mortgages worth over $1 trillion are due to reset in the next two years. "We've never had such a high percentage of loans come due at the same time, so no one really knows what will happen," says RealtyTrac Vice President Rick Sharga.
Currently, foreclosures represent only about 1 percent of all outstanding loans, far below the rate after the last big real- estate downturn began in the late 1980s. Yet borrowers who take out adjustable-rate and subprime mortgages tend to default more often than those with conventional fixed-rate loans. Some worry that mortgage defaults could flood the market with inventory just as demand is cooling.
Lenders have little incentive to force that situation, especially now--when the properties they repossess could end up languishing on the market. Instead, some may be willing to restructure the loan or reduce payments in the short run if the borrower makes them up later. Even in the worst situations, lenders sometimes will accept a "deed in lieu of foreclosure," in which the property is returned to the lender without leaving an indelible black mark on the borrower's credit rating.
"I understand the embarrassment of not being able to meet your obligations, but the smartest thing you can do if you're having trouble is to call your lender and ask what your options are," says Duncan. "Unfortunately, a lot of people wait until it's too late."
This story appears in the August 7, 2006 print edition of U.S. News & World Report.