By: Yara Zakharia, Esq.While the undercurrents to a mortgage implode have been stirring beneath the surface for years, they became a visible force to be reckoned with during the mortgage crisis of 2008. In January of this year, there were 57% more foreclosures than in January of the previous year. Unemployment in the United States skyrocketed, and the deterioration in the quality of credit became evident in the subprime mortgage market. The subprime mortgage crisis grew out of the U.S. housing market's crash and the dramatic rise in default rates on adjustable rate mortgages (ARM) and subprime mortgages issued to borrowers who
- Were higher-risk than "prime" borrowers
- Had little or no equity in their home
- Could not prove an ability to repay the mortgage loan, and/or
- Were situated in the low-income bracket.
The practice of subprime lending involves the issuance of loans to homeowners who are not eligible for market rates of interest due to employment status, credit score, amount of deposit, level of income, or other criteria. The payment default rate for subprime borrowers of ARMs rose significantly due to a number of different factors. Encouraged by accessible credit, a lasting trend of appreciating home values, and loan incentives, many subprime borrowers took out ARMS, operating on the belief that they would subsequently have the opportunity to refinance at more attractive terms. However, home prices dipped in some markets, making refinancing more challenging or altogether impossible.
In fact, real estate prices across the U.S. posted the longest period of depreciation since 1990. With their American home mortgage reset to a higher rate of interest and payment, an increasing number of borrowers defaulted. Others became unwilling or unable to pay their mortgage and allowed foreclosure to take effect. By May 2008, the rate of delinquency on subprime loans stood at 25%. Another contributing element was predatory borrowing, which typically takes the form of misrepresentation of information on loan applications. One recent survey found that fraudulent misrepresentations on loan applications were implicated in as much as 70% of payment defaults in 2008. It was also found that the likelihood of default is five times higher for applications containing misrepresentations.
These events led to a substantial decrease in liquidity in several markets. Having assumed the risk of payment delinquency, mortgage lenders - which were the first to be impacted- started issuing fewer loans or offered them at higher rates of interest. Owing to the decrease in lending, the subprime mortgage crisis depressed economic growth since it prompted businesses and consumers to invest and spend less, respectively. Another factor contributing to the subprime mortgage crisis was the shakeup in the housing market, which witnessed a considerable decrease in new home construction, a sharp fall in real estate prices, and an oversupply of homes.
Tighter financing standards and falling home prices had deleterious consequences not only on subprime borrowers, but also on homeowners with solid credit and payment histories and who are on top of their finances. With this segment of borrowers unable to pay their mortgage, prime delinquencies have been on the rise. As with subprime loans, prime borrowers were granted the opportunity to pay a lesser amount at the outset and adjust to higher payments down the line. Their hopes of refinancing their mortgages were dashed due to the clampdown by lenders and the depreciation of home values, the latter causing prime borrowers to owe an amount exceeding the value of their home.
However, other adverse influences have also been at play:
1. Upward mortgage rate trends
With current mortgage rates on the rise, prime borrowers who obtained an ARM have found it more difficult to make payments. Many purchased homes that were above their financial means by relying on an interest-only mortgage or an ARM. Interest rate cuts by the Federal Reserve which were aimed at reducing the potentially higher costs occurring when ARMs reset have been unsuccessful in offsetting the effect of rising payments driven by elevated current mortgage rates. In fact, even after the Feds' largest proffered cut in 25 years- namely 3%- prime borrowers are succumbing to the same financial insecurity facing many subprime borrowers.
2. Job losses
Even prime loan holders with mortgages which are eligible for purchase by Freddie Mac and Fannie Mae are coping with economic hardship as a result of job losses. An unforeseen change in employment stability has left an increasing number of prime borrowers incapable of paying their mortgage bills and has raised delinquencies.
Notwithstanding the turmoil in the American home mortgage industry, financial institutions, the U.S. Treasury Department, and the Congress have instituted corrective measures to mitigate the effects of the mortgage implode. Some of the actions taken include 1) a program to defer or limit adjustments to the interest rate, 2) a call to both borrowers and creditors to cooperate and permit the former to remain in their homes, 3) a cap on home equity lines of credit, and 4) more than $250 billion in supplemental funds offered by investors to lenders for purposes of offsetting losses.
