Soaring housing prices and aggressive mortgage lending have saddled homebuyers with ever greater levels of debt, and early signs are now emerging that more people are unable to keep up with their monthly mortgage payments.
Recent studies by several Wall Street firms point to rising delinquency rates on home mortgages that were issued last year, a period when lenders were pushing hard-to-keep business going as interest rates and home prices were rising. The increase in late loan payments comes as more buyers have been forced to stretch financially to afford ever-costlier houses in recent years, and many homeowners have increased debt by tapping their home's equity. Analysts say that laxer lending standards on the part of mortgage lenders also resulted in higher debt loads, which some borrowers are now struggling to repay.
To be sure, mortgage delinquencies remain low by historical standards. But experts worry the trend could worsen.
With the housing market cooling and interest rates rising, "by the end of the year you could see a substantial increase in delinquency rates" for mortgages, says Thomas Lawler, a former Fannie Mae (NYSE: FNM) economist and now a private housing consultant.
Mortgage delinquencies historically peak around three years after loans are made, which means some of the more aggressive loans made last year might experience their biggest problems in 2008.
However, some borrowers with adjustable-rate mortgages could see problems sooner. Others, who took out exotic mortgages such as interest-only loans and option ARMs that hold down monthly payments in their early years, could run into trouble later, when payments reset. Still, there are early signs that even some of these nontraditional mortgage loans are starting to be squeezed by rising interest rates.
Borrowers who took out mortgages in the past two years are likely to be more vulnerable should home prices fall because they could wind up owing more than their home is worth. Twenty-nine percent of borrowers who took out mortgages last year have no equity in their homes or owe more than their house is worth, according to a study completed this year by Christopher L. Cagan, director of research and analytics for First American Real Estate Solutions, a unit of First American Corp. (NYSE: FAF). That compares with 10.6 percent of those who took out loans in 2004.
An analysis by Bear Stearns found that delinquencies on loans originated in 2005 were in most cases far higher than on loans issued in previous years at the same point in their life cycle. "The numbers are clearly worse," says Gyan Sinha, a senior managing director at Bear Stearns. The reason: Lenders were "able to generate a lot more volume in the face of rising rates" by loosening lending standards, Sinha says. "More aggressive lending was clearly taking place," he adds.
A separate study by Credit Suisse reached similar conclusions. That study looked at borrowers with good credit who were at least 90 days late on their mortgages. Credit Suisse found that borrowers who took out adjustable-rate mortgages in 2005 were three times as likely to be delinquent on their payments after the first year as those who took out ARMs in 2003 and 2004.
Payments on ARMs can adjust after as little as a month, or after several years, depending on the terms of the loan. (The study didn't include borrowers with option ARMs.)
The higher delinquency rate for ARMs could be a sign that many financially strapped borrowers have turned to these loans to boost affordability, says Satish Mansukhani, head of mortgage strategy at Credit Suisse. The findings are "an early warning signal that merits watching," he says.
In a sign that looser lending standards could be taking their toll, Credit Suisse also found that borrowers who were delinquent were more likely to have lower credit scores and to have taken out piggyback mortgages, which combine a mortgage with a home-equity loan or line of credit. It also found that delinquency rates were shooting up in California, where double-digit gains in home prices have made affordability an issue.
In another sign that some borrowers who stretched are now feeling pinched, a study by Lehman Brothers (NYSE: LEH) of subprime borrowers found that the increase in delinquencies is being driven by homebuyers, rather than by people who are refinancing, and by those with little equity in their homes. All three studies by the Wall Street firms looked at mortgages sold to investors who buy mortgage-backed securities and excluded loans purchased by mortgage giants Fannie Mae and Freddie Mac (NYSE: FRE).
Overall, roughly 4.7 percent of residential mortgages were delinquent in the fourth quarter, the Mortgage Bankers Association (MBA) says. Excluding the effects of Hurricane Katrina, delinquencies were 4.55 percent. That is up from 4.44 percent in the third quarter and 4.38 percent at the end of 2004, it says.
Mortgage lending standards tended to be looser in 2004 and 2005 than in the previous three years, according to surveys done by the Federal Reserve Board. One example: Piggyback loans have become more common, enabling borrowers to use as much as 100 percent debt to finance a home purchase.
And with competition for borrowers increasing and profit margins shrinking, the move toward looser standards is continuing. Roughly 10 percent of mortgage lenders said they had eased credit standards in the three months ended April, according to a Fed survey released this week. Only one of the 53 banks surveyed reported any tightening of standards.
"It would be very surprising if people were tightening in a declining market," says Doug Duncan, chief economist of the MBA.
The Bear Stearns analysis found that, depending on the type of loan, delinquency rates were anywhere from 33 percent to 208 percent higher after the first year for most types of mortgages taken out in 2005 compared with those issued in 2004. The highest one-year delinquency rate was for borrowers with poor credit who took out adjustable-rate mortgages with rates that reset in two years; 5.14 percent of those loans were seriously delinquent after the first year, a 35 percent increase from a year earlier.
The pattern also held true for jumbo loans -- currently mortgages above $417,000 -- and for most mortgages issued to borrowers with good credit who don't fit traditional lending standards, such as those who don't provide full documentation when taking out a loan. The Bear Stearns analysis looked at loans that were considered at least 60 days past due.
Borrowers with interest-only loans and option ARMs, popular affordability products, have generally had lower delinquency rates early in the loan's lifecycle than those with other types of mortgages, in part because their initial payments are relatively low. But there are some indications that this is changing.
Gail Burks, president of the nonprofit Nevada Fair Housing Center, says borrowers are coming into her office who are having trouble making their payments as soon as a year or two after taking out a mortgage. "It's more of the newer, exotic (mortgages) where the payment has changed and they are now pretty much priced out of the loan," she says.
A recent analysis prepared for The Wall Street Journal by LoanPerformance, a unit of First American Corp., found that borrowers with jumbo loans who took out interest-only mortgages and option ARMs in 2003 and 2004 are more likely to be 30 or 90 days late on their payments than borrowers with more traditional mortgages.
Among borrowers with poor credit, delinquency rates have tended to be lower for those with interest-only mortgages than for those with traditional loans. But that edge is disappearing after about two years for interest-only mortgages taken out in 2003 and after just one year for loans taken out in 2004 and 2005, according to Dominion Bond Rating Service. These mortgages are expected to see greater delinquencies going forward as the housing market cools because "the interest-only borrowers are overleveraged," says DBRS Senior Vice President Quincy Tang.