The Rate and the Number of Foreclosures - Essay Example

Foreclosure Market Research The rate and the number of foreclosures increased during 2006, and have been trending upward ever since. According to the National Delinquency Survey, the rate of delinquency (percent of loans 30 or more days delinquent) for all loans was 9.64%, up from 9.24% in the second quarter of 2009. This compares to 6.99% one year ago and 5.59% two years ago. The percentage of loans in the foreclosure process went from 4.30% in the second quarter of 2009 to 4.47% in the third quarter, compared with 2.97% one year ago and 1.69% two years ago (Mortgage Bankers Association 10-11). The number of annual foreclosure filings rose from 1.3 million in 2006 to 2.2 million in 2007, to 3.3 million in 2008, and to almost 4.0 million in 2009 (RealtyTrac). In order to determine whether foreclosure will continue, it is first necessary to determine the causes of these higher foreclosure rates and then to determine whether those causes are continuing. Foreclosures occur because an individual with a mortgage cannot afford the mortgage any longer and because the individual will not recover the amount of the mortgage from the sale of the home. So it is necessary to figure out what might cause individuals to have difficulty affording a mortgage and for the house values to decline below mortgage values. What might cause a decline in mortgage affordability would be closely related to all macroeconomic measures that affect income. So GDP and the unemployment rate will certainly affect incomes and thus home affordability, since less GDP means less economic activity, which in turn means declining profits and more unemployment. Obviously, lower profits and more unemployment translates into less money for people and thus more people unable to afford their mortgages. In fact there has been an extremely close correlation between unemployment rate and mortgage delinquency. One analysis has found a correlation of 98% between unemployment rate and delinquency rate between 2004 and the middle of 2009 (Calculated Risk). This close relationship is a contrast to what has been evidenced in the past, as the correlation between foreclosure rates and unemployment rates were found to be weak before this latest housing boom/bust cycle. In 1998 two economists examined the relationship between unemployment and mortgage foreclosure rates from 1950 to 1998, and concluded that there was very little correlation between unemployment changes and mortgage foreclosures (Elmer and Seelig). Yet because of the changing nature of mortgages beginning in the 1990s, the association between foreclosures and unemployment has become quite significant. Traditionally 20% downpayments had been the minimum requirement for most borrowers, but this requirement was increasingly weakened over the last 10-15 years (Calculated Risk). Therefore suddenly unemployed or underemployed homeowners who must sell may find themselves with mortgages worth more than the value of the home, due to the lack of equity and the declining home values, and will therefore have to foreclose. So as long as there is high unemployment and declining home values, more foreclosures are likely to occur. The decline in the house value below the mortgage value would occur if housing prices have fallen from the original time the mortgage was issued. Home prices began their decline in the middle of 2006 and have fallen to 2003 levels, and have shown modest increases since the beginning of 2009 (Case-Shiller). So homes that were purchased after 2003 are the most vulnerable to foreclosure. Home purchases before 2003 will be vulnerable to foreclosure if there was refinancing. The closer in time the home purchase or refinance was to the peak of mid-2006, the more vulnerable that loan will be to foreclosure, since those loans will have the highest mortgage/home value ratios. During the 1990s, mortgage loan originations (both purchase and refinance) were around 200 billion per quarter. This number began to rise in the late 1990s, fell back briefly, and started to rise again in 2001 until reaching a peak of around 1.2 trillion in the later quarters of 2003. In 2007 loan originations were still around 600 billion per quarter; in the first quarter of 2009 loan originations had fallen to around 300 billion (Mortgage Statistics). The fact that home prices have fallen so far so fast, coupled with the enormous increase in loan originations after 2003 when prices were so high, is another explanation for the recent high unemployment and foreclosure rate correlation and for the current foreclosure crisis. The high foreclosure rates will be exacerbated by the number of higher loan mortgage to home value ratio (LTV) loans outstanding. The down payment will significantly affect default risk, since borrowers with 0% down will likely default if they can no longer afford their mortgages and prices drop below purchase price, whereas borrowers with 20% down (loan to value=80%), for example, will likely default if they can no longer afford their mortgages and prices fall more than 20% below the original price. If prices fall below the original purchase price yet less than the down payment percent, the original buyer will likely sell and hence recover some of their down payment rather than allow the house to enter the foreclosure process and receive nothing. The sale will create downward pressures on home prices, but such sales will be a function of income/employment measures only. Another essential consideration is the creditworthiness of the mortgages. Mortgages with more stringent credit and income requirements are obviously less likely to default, since the higher the financial quality of the borrower, the less likely the borrower will default, whether the economic climate is favorable or not. In the third quarter of 2009 prime mortgages had a foreclosure rate of 3.20% versus 15.35% for subprime mortgages, which are borrowers with lower credit quality. Mortgages with teaser rates and ARM mortgages will have a higher default risk since payments will increase with time, increasing the risk of future default. ARM mortgages had a 3rd quarter 2009 foreclosure rate of 14.17%, compared with 2.51% for fixed rate mortgages (Mortgage Bankers Association 10-11). Subprime mortgages also tend to have higher LTVs. Subprime and Alt-A mortgage originations went from about 1.4 million in 2003 to 3 million in 2005 and simultaneously went from a median LTV of 90% to 100% (Mayer, Pence, and Sherlund). Subprime mortgages increased dramatically in the early 2000's, coinciding with the dramatic appreciation in home prices. In 2001 subprime loans made up 8% of residential mortgage originations and only 3% of all outstanding loans. By 2006, right around the time of the peak in home prices, subprime mortgages made up 20% of all residential originations and 13% of all outstanding mortgages (Krinsman 13). The Center for Responsible Lending claims that it is possible to see 13 million more homes going into foreclosure over the next five years (Kuhlmann). Rick Sharga of RealtyTrac estimates that between 3 and 3.5 million homes are expected to enter the foreclosure process in 2010 (RealtyTrac). This is down from 4.0 million in 2009 and around the same as the 3.3 million in 2008. So the expectation is that foreclosures may have peaked in 2009, but there still is a tremendous number of foreclosures that will occur, far more than used to occur before the housing meltdown, when foreclosures were less than 1 million. This is consistent with the underlying determinants of foreclosures. First of all, the high unemployment rate may not improve much in 2010, if at all. Federal Reserve policymakers predict that unemployment will remain above 9% throughout 2010 (Andrews B4). Secondly, although home prices seem to be stabilizing, modest increases will not bring back the high home prices in which homebuyers purchased their homes after 2003. Furthermore, there are still a lot of high-risk subprime and ARM mortgages outstanding, many of which originated after 2003. It is estimated that around 25% of mortgages at the end of 2009 were in these high-risk categories: either subprime or prime ARM mortgages (Mortgage Bankers Association 10-11). And with current foreclosure rates in these high-risk categories at 10-25%, foreclosures will still be commonplace for at least another couple of years. Another threat to the housing recovery worth mentioning is the option ARM. Many option ARM originated between 2004 and 2008. Option ARMS normally reset after five years with considerably higher rates and payments. It is estimated that around 1 million ARMs will reset in the next four years, with three-quarters of those to reset in 2010 and 2011 (Louis). A possible wild card that could improve the situation would be government intervention. The Home Affordable Modification Program (HAMP) was established in February 2009 to help troubled homeowners modify their mortgages and avoid foreclosure. Yet even though around 760,000 homeowners received loan modifications on a trial basis, only 31,000 modifications were made permanent. With such a low success rate, unless there are significant changes or more intrusive interventions in the future, government actions are unlikely to seriously impact foreclosure rates (Kuhlmann). To the extent that the local trends in Minneapolis, Minnesota mirror the national trends, a large number of foreclosures should be expected in Minneapolis in the next couple of years, although not quite as many as occurred in 2009. Home price movements in Minneapolis and Minnesota have followed the similar national pattern of peaking in 2006, and falling to around 2003 levels, before showing some rise the latter part of 2009 (Case-Shiller Index). Although the foreclosure rates are slightly lower in Minnesota (foreclosure rates of 3.43% in Minnesota versus 4.47% nationally for all loans, 2.41% versus 3.20% for prime loans, 15.13% versus 15.35% for subprime loans in 2009Q3), the growth trends are still similar (Mortgage Bankers Association). The national unemployment rate went from 7.4% in December 2008 and increased steadily to the current 10.0% for December 2009. In Minnesota the rate went from 6.6% in December 2008 (6.4% in Minneapolis) to 7.4% (7.0% in Minneapolis) in December 2009. However, the Minnesota unemployment rate peaked at 8.4% (8.5%) in June 2009, so there is the suggestion of possible declining and lower unemployment rates versus the national trend (United States Department of Labor). Also, compared with the entire country, Minnesota has a slightly higher percentage of mortgage loans that are higher quality prime fixed rate mortgages at 82%, compared with 74% nationally (Mortgage Bankers Association). In the city of Minneapolis, Minnesota, the number of foreclosures was 2895 in 2007 and 3077 in 2008. From January to October 2009 there were 1896 foreclosures so that the 2009 total is likely to be around 2300 (CPED Research). So foreclosures in 2009 will likely be somewhat lower than the peak year of 2008. Given the slightly improved condition of Minnesota compared with the nation overall, there should be some improvement in foreclosures in the next year. Yet the basic foreclosure determinants (higher than normal unemployment, high percentage of high- risk loan groups, high LTVs from recent home price deterioration) are firmly in place at the local level, so there will likely be continuing foreclosures, if at a somewhat reduced pace. Therefore, it would seem that any business that provides services involving foreclosures will be a sensible strategy, with the understanding that business opportunities will be plentiful in the next couple of years while at the same time begin to dwindle. As the economy eventually emerges from its downward cycle, the lower quality subprime and ARM mortgages initiated during the housing boom years after 2003 are liquidated, and the housing market stabilizes, the prospects for business opportunities in the foreclosure arena become increasingly uncertain and will likely begin to decline steadily. Works Cited Andrews, Edumnd L. "Fed Cautious About Strength of Recovery." New York Times 25 Nov. 2008, New York Ed.: B4. Calculated Risk. "A New Correlation Between Unemployment and Foreclosures" 29 June 2009. Case-Shiller Home Price Index for United States and Minneapolis, MN metropolitan area. 2000- 2009, Macromakets Online, http://www.macromarkets.com/csi_housing/index.asp (accessed January 24, 2010). CPED Research. "City of Minneapolis Number of Foreclosures Citywide October 2009" 22 Dec. 2009. Elmer, Peter J. and Steven A. Seelig. "The Rising Long-Term Trend of Single-Family Mortgage Foreclosure Rates," Federal Deposit Insurance Corporation Working Paper No. 98-2, 1998. Krinsman, Allan N. "Subprime Mortgage Meltdown: How Did It Happen and How Will It End" The Journal of Structured Finance 13.2(Summer 2007): 13-19. Kuhlmann, Arkadi. "Why Mortgage Modification Isn't Working." Wall Street Journal Online 20 Jan. 2010. Louis, Brian. "Option ARMs Reset Threatens Housing Rebound." The Seattle Times Online 27 June 2009. Mayer, Christopher, Karen Pence, and Shane Sherlund. "The Rise in Mortgage Defaults." Journal of Economic Perspectives 23.1(2009): 27-50. Mortgage Bankers Association. National Delinquency Survey 19 Nov. 2009: 10-11. Mortgage Statistics. "19 Years of Mortgage Origination Data." 13 Feb. 2009. RealtyTrac. "U.S. Foreclosure Activity Increases 75% in 2007." 29 Jan. 2008. > RealtyTrac. "RealtyTrac Year-End Report Shows Record U.S. Properties With Foreclosure Filings in 2009." 14 Jan. 2010. United States Department of Labor. Bureau of Labor Statistics. Unemployment Rate, December, 2008 to December, 2009. Current Population Survey. Washington: GPO, 2010. Read More