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Subprime loans face big
hikes
By
Ron Scherer Thu
Aug 30,2007 4:00 AM ET
New York - Millions
of homeowners around the nation are now getting the news in
the mail: The interest rate on their home loans is going up,
possibly to double-digit levels.
The hardest hit are
expected to be people who have less-than-stellar credit and
cannot afford to make the new payments. An increase of several
hundred dollars a month will force them either to get relief
or to default. The prospect of significant and growing losses
has already rocked Wall Street and shaken up the broader
mortgage markets. And, concerned about the human suffering,
policymakers are already searching for ways to help people
out.
"The meltdown in
the subprime market is the biggest threat to the housing
market and the broader economy," says Mark Zandi, chief
economist at Moody's Economy. com. "It is at the vortex of the
problem."
Over the next
several months, banks will be changing the "teaser rates" that
homeowners received two years ago.
The peak for
resetting loans will be in October 2007, when the rates on
some $50 billion worth of mortgages are likely to rise by 2
percentage points or more. This could mean a rise of several
hundred dollars a month for many borrowers.
For example, on a
$210,000 loan balance (the average subprime amount in 2006),
the additional 2.5 percentage point increase on the interest
rate adds about $4,560 a year, or about $380 a month,
estimates James Kragenbring, senior investment officer at
Advantus Capital Management in St. Paul, Minn.
That means the
median household would have to devote an extra 9.5 percent of
income just to pay the extra interest.
"Given the
debt-to-income ratio of the typical subprime borrower at the
time they received their loan, it is unclear where the extra
cash flow will come from," says Mr. Kragenbring.
Interest costs rise
faster than pay
It probably won't come from a pay raise, if recent trends
continue. Last year, median household income rose 0.7 percent
to $48,201, the US Census Bureau reported Tuesday.
"If mortgage
payments are rising faster than the 0.7 percent average growth
rate, then they are rising faster than incomes and that could
create problems," says Chuck Nelson, of the Census Bureau.
It's already
creating problems in Buffalo, N.Y.
"If the borrower is
on Social Security, the most their income is rising is 3
percent a year and the mortgage payments are rising much
faster than that," says Carol Brent, staff attorney of Legal
Services for the Elderly.
She says she has
clients whose monthly income is $800 a month but whose
mortgage payments have now mushroomed to $500 a month. "No one
looked at the affordability factor."
As the interest
rates have climbed, the percentage of delinquencies is on the
rise. Of the loans made in 2001, nearly 30 percent are now at
least 60 days past due. Loans made last year now have nearly a
15 percent delinquency rate, a faster growth rate than any
other year (see chart at left). Mr. Kragenbring says the most
recent loans in 2007 are not performing much better.
Community groups
report that lenders are still making loan offers with
unrealistic rates. One group in New York City says it has seen
postcards advertising a teaser rate of 1.5 percent. But under
that scenario, the borrower is paying less than the full
amount of interest owed, which increases his debt. "What they
don't tell you is [that] these very low monthly payments ...
are rapidly building up debt and then they reset at an
unaffordable level," says Oda Friedheim of the Legal Aid
Society in Queens.
After foreclosures,
vacant homes
The rising level of delinquencies is leading to a sharp rise
in foreclosures. In Buffalo, Ms. Brent says there are now
23,000 vacant homes, many of them emptied by foreclosure
procedures. "We are trying to work with the attorneys who are
seeing the light because of the number of foreclosures," says
Ms. Brent. "We are working on ways to structure repayment
plans so the borrowers are not back in foreclosure in two
years."
The defaults are
now taking place much faster than a few years ago, says Sarah
Ludwig, executive director of the Neighborhood Economic
Development Advocacy Project, which works with community
groups in New York City.
"In Queens, the
time frame in which people are defaulting has gone from four
years to two years," says Ms. Ludwig. "That means some
defaults are taking place right away."
Refinancing is not
a significant option for many borrowers. "What I hear is that
there is very little activity in the subprime market,
especially where questions of credit quality have grown in
rapid proportions," said David Seiders, chief economist for
the National Association of Home Builders, in a press
conference on Tuesday.
Kragenbring says
the volume of subprime loans now being made is tiny compared
with last year. And lenders are finding it tough to find
buyers for the new loans in the secondary market. "To me, that
makes the subprime market virtually nonexistent," he says.
Subprime lenders
First Franklin, owned by Merrill Lynch, and EquiFirst, owned
by Barclays, maintain they are still making loans. However,
they refused to comment about where they were receiving
funding for the loans. On Tuesday, EquiFirst announced an
unspecified number of job cuts.
If the market for
subprime debt returns, Kragenbring expects three major
changes. First, loans will be for a fixed interest rate, not
the adjustable version. "It will help match the time people
live in the house and the borrowers will pay less fees," he
says. Second, lenders will require much better documentation
of income. Third, borrowers will be borrowing a smaller
percentage of the value of their homes.
"It's clear to me
that in the future there will be different loan products and
less leverage on the individual property," Kragenbring adds".
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