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U.S. banks move earlier to curb foreclosures

As the number of borrowers falling behind on their mortgage payments climbs to the highest level in five years, the mortgage industry is trying new strategies to help bail them out.

Much of the attention is on homeowners who in recent years took out adjustable-rate mortgages, a popular way to finance a home when interest rates were low. Now, with rates having moved up, many of these borrowers have recently seen, or soon will see, their mortgage rates adjust higher for the first time.

To head off problems, mortgage companies are reaching out to borrowers earlier. Bank of America Corp. (NYSE: BAC) is allowing some borrowers with ARMs to refinance into a different loan at no cost. Citigroup Inc.'s (NYSE: C) CitiMortgage unit is focusing extra attention on parts of California, Florida and New York where home prices have moved up sharply. It is also contacting delinquent borrowers within days after a missed payment, if it doesn't fit their normal bill-paying habits.

The rise in bad loans also is leading to a pick up in so-called short sales, in which a lender allows the property to be sold for less than the total amount due and often forgives the remaining debt. For the lender, the process can be shorter and less costly than foreclosing, especially in a declining market. For borrowers, it is a way to avoid having a foreclosure on their credit report.

Sheldon Klain, a manager in Dallas, wound up saddled with loans on two homes last year and now is trying to arrange a short sale of one of them. Klain got into trouble after he moved to Dallas from Las Vegas to take a new job. He bought a home in Dallas, thinking he had found a buyer willing to pay $475,000 for his Las Vegas home. The sale fell through at the last minute and Klain found himself stuck with two homes and behind on payments on the Las Vegas house.

Klain says his Las Vegas house, which is in a gated community and has a swimming pool, is valued at $419,000, according to a recent bank appraisal, well below the $440,000 he owes on the property. "The dump in the market put us behind the eight ball," he says.

For some borrowers, efforts to work out bad loans can be complicated by the fact that many mortgages no longer are held by the banks that made the loans. Instead, roughly two-thirds of mortgages are packaged into mortgage-backed securities and sold to investors. How much leeway a borrower is given can vary, depending in part on the rules spelled out at the time the securities are created. Some agreements, for instance, don't permit loan modifications or limit the circumstances under which a loan can be modified. Others put a cap on how many loans can be restructured.

Some 2.51 percent of mortgages were delinquent in the fourth quarter, according to new data from Equifax Inc. (NYSE: EFX) and Moody's (NYSE: MCO) Economy.com Inc. That is up from 2.33 percent in the third quarter and the highest level since a recent peak of 2.53 percent in the first quarter of 2002.

The increase in bad loans is broad-based, with delinquencies rising in the past year in roughly 80 percent of the 250 local areas analyzed by Moody's Economy.com. Some of the biggest increases have come in California, where high prices have made it hard to afford a home, and in other once-hot markets such as Las Vegas and Port St. Lucie, Fla. Among the handful of major metropolitan areas where delinquencies have fallen: Salt Lake City, San Antonio and Albuquerque, N.M.

The rise in delinquencies is unusual because it comes at a time when the economy is relatively strong. Even though job growth remains healthy, "the total mortgage delinquency rate is the highest that it's been since the depths of the (2001) recession," says Mark Zandi, chief economist at Moody's Economy.com. He attributes the increase in part to the weaker housing market and the widespread use of adjustable-rate mortgages, many of which now are resetting at higher rates.

What is more, as demand for loans softened, mortgage lenders loosened their standards and made riskier loans, Zandi says. He expects that nationwide delinquency rates could rise by as much as a full percentage point from current levels in the next year, but he doesn't expect the trend will have a significant impact on the overall economy.

Until recently, mortgage delinquencies were low by historical standards, which Zandi pegs at about 2 percent, based on the dollar value of loans that are at least 30 days past due. One reason: Rising home prices made it easy for borrowers who missed payments to refinance or sell their home. That changed as home prices flattened or fell in many areas.

Adding to the pain are higher short-term interest rates, which mean bigger monthly payments for borrowers with adjustable-rate mortgages or home-equity lines of credit. In addition, many mortgages were taken out in the past few years and now are approaching the point in their life when delinquencies typically pick up. An increase in mortgage fraud in parts of the country also has contributed to bad loans, lenders say.

"Keep in mind that 2004 and 2005 were aberrations," with low delinquencies and rapid home-price growth, says Michael Fratantoni, an economist with the Mortgage Bankers Association. He says the biggest increase in delinquencies has been among borrowers with scuffed credit records who took out adjustable-rate mortgages.

To head off potential problems, CitiMortgage contacts borrowers with adjustable-rate mortgages by phone and by mail monthly, beginning months before the rate on their loan resets, to alert them to the upcoming payment increase and explain their options, says CitiMortgage President Bill Beckmann.

Bank of America is using computer models to predict which borrowers may run into trouble -- even before they miss a payment. "We're calling earlier and more often" because it increases the chances that a borrower's problems can be worked out, says Bob Caruso, Bank of America's national servicing executive.

Among the bank's options: Borrowers who miss a payment because of illness or job loss may be allowed to add the unpaid debt to their loan balance, Caruso says. Other kinds of loan modifications also are becoming more common. These include arrangements that allow a troubled borrower to refinance into a less costly loan or that lower the interest rate on the mortgage for several years to make the payments more affordable.

Mortgage companies also are looking for additional ways to reach financially stretched borrowers. In some of the Midwestern markets where it has bank branch offices, National City Corp. (NYSE: NCC) is working with local clergy, United Way organizations, social workers and housing counseling agencies to help borrowers reluctant to talk with their lender. The bank's Web site explains workout options and allows borrowers to apply online for assistance. National City is one of a dozen major lenders behind a national advertising campaign that will, beginning this spring, promote a toll-free number (888-995-HOPE) borrowers can call for homeownership counseling and referrals.

Bank of America says it has seen short sales of homes increase 25 percent from last year, albeit coming off of relatively low levels. And in San Diego, the number of entries in the local multiple-listing service that include the words "short sale" has climbed to 98 from about 50 a year ago, according to Sandicor Inc., the local multiple-listing service. A short sale can be less of a black mark than a foreclosure on a borrower's credit record, because it indicates the borrower was working with the lender.

There can be downsides for borrowers to short sales. Under certain circumstances, the debt forgiven by the bank may be taxable to the borrower. What is more, convincing a lender to go along with a short sale can be difficult, and borrowers who have a mortgage and a home-equity loan may have to negotiate with two lenders or two departments of the same bank.

"There are all sorts of log jams," says John Izzo, the agent handling the sale of Klain's Las Vegas house. Izzo says he is currently working on 19 short sales, but figures just "one in five might be successful."

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