Tuesday, July 15, 2003

By Jessica Swesey
Inman News Features

Record foreclosure rates in the first quarter of this year don't signal danger ahead in the nation's housing market. However, foreclosures do suggest cooling home price appreciation and reflect the inherent risk of subprime loans.

Mike Sklarz, chief valuation officer at Fidelity National Information Solutions, researched correlations between median price appreciation rates and foreclosure levels in California and found that year-ago price trends were even more significant than current price trends in explaining current foreclosure levels.

The Mortgage Bankers Association reported the volume of home loans in the process of foreclosure edged up to a record 1.2 percent in the first quarter of 2003, yet home prices remained at or near record highs in most areas.

The fact that both foreclosures and home prices were rising at the same time might seem contrary to historical patterns because rising home values would tend to provide financially-strapped homeowners an exit from their difficulties. However, a closer look at the data shows that the superficial conclusion is not the whole story. In fact, the inverse relationship between home price appreciation and foreclosures still exists.

Sklarz said even a leveling out of home price appreciation would be enough to cause foreclosures to rise, but not enough to significantly ail the housing market."

(Foreclosures) are still (at) very low numbers in the grand scheme of things," he said.

Home prices may still be high, but the national rate of home price appreciation has slowed continuously over the past three quarters, according to the Office of Federal Housing Enterprise Oversight's house price index. OFHEO reported the first-quarter rate of appreciation decelerated to 0.94 percent compared with 1.3 percent the previous quarter and 2 percent a year earlier.

OFEHO has been under fire for its failure to discover home loan financier Freddie Mac's significantly underreported revenues; however, economists still credit the regulator's housing market statistics.

Sklarz noted that the inverse relationship between foreclosures and home price appreciation doesn't explain all foreclosure scenarios. The basic reasons why homeowners default on their mortgages include divorce, loss of a job or taking on too much debt.

An increase in foreclosures historically has indicated a troubled housing market and price depreciation, since a hot market would enable a homeowner facing default to sell quickly and avoid foreclosing. But experts point out that the tanking national job market and high-risk borrowers who purchased their homes by obtaining a subprime loan are cause for the current highest national foreclosure rate on record.

Sklarz said the housing boom has masked most of the pitfalls of subprime lending.

"As long as the market is rising, there's no problem. But as soon as the market falls, those problems become amplified," he said.

Subprime loans are inherently risky. Lenders write loans with higher interest rates and higher fees to borrowers who don't have the necessary credit or down payment to qualify for conventional, less-costly loans.

Anything that creates more borrowers who are less creditworthy adds to foreclosure risk, Sklarz added.

He said higher loan-to-value ratios accurately predict a higher incidence of mortgage defaults and foreclosures. High LTVs result from low down payment loans, borrowers adding more debt to their properties with home equity loans or a drop in home prices.

"The higher the LTV ratio, the more precarious the homeowner is," he said.

MBA Chief Economist Doug Duncan said the slow pace of job recovery and the expansion of the subprime mortgage market spurred the record foreclosure rate. But foreclosures alone aren't enough to disrupt housing market fundamentals, which remain strong.

"If you look at supply and demand characteristics in the overall housing market, you'll see that supplies of property have been very modest, especially for recession and post-recessionary periods," Duncan said.

He dismissed the idea that the cash-out loan refinancing phenomenon would significantly increase the volume of delinquencies. Historically low interest rates enabled homeowners to add more debt to their mortgages when they refinanced or obtained a home equity loan.

Alexis McGee, president of Foreclosures.com, a company that tracks and publishes foreclosure data, said the increase in foreclosures is mostly due to a weak job market. The recession cut a lot of people out of high-paying jobs and forced them into lower-paying positions.

"These people are employed and can afford a mortgage, but not the one they currently have," she said.

People will do anything to keep from losing their homes, she added, so instead of selling their houses they can no longer afford they end up falling behind on payments. This damages their credit scores, which makes it more difficult to refinance into a monthly payment they can afford.

However, she said, more lenders are allowing borrowers to remain delinquent on their mortgages for a longer period of time than they used to permit before pushing the property into foreclosure. That forbearance is another factor in foreclosure rates.