Americans who have stretched themselves financially to buy a home or refinance a mortgage have been falling behind on their loan payments at an unexpectedly rapid pace.
The surge in mortgage delinquencies in the past few months is squeezing lenders and unsettling investors worldwide in the $10-trillion U.S. mortgage market. The pain is most apparent in subprime mortgages, though there are signs it is spreading to other parts of the mortgage market.
Subprime mortgage originations climbed to $625-billion in 2005 from $120-billion in 2001, according to Inside Mortgage Finance, a trade publication. Like other types of mortgages, subprime home loans are often packaged into securities and sold to investors, helping lenders limit their risks.
Until the past year or so, delinquency rates were low by historical standards, thanks to low interest rates and rising home prices, which made it easy for borrowers to refinance or sell their homes if they ran into trouble. But as the housing market peaked and loan volume leveled off, some lenders responded by relaxing their lending standards. Now, the downside of that strategy is becoming more apparent.
Based on current performance, 2006 is on track to be one of the worst ever for subprime loans, according to UBS AG.
"We are a bit surprised by how fast this has unraveled," says Thomas Zimmerman, head of asset-backed securities research at UBS. About 80,000 subprime borrowers who took out mortgages packaged into securities this year are behind on their payments, the bank says.
Though delinquency rates on subprime mortgages originated in the past year have soared to the highest levels in a decade, economists don't expect any significant harm to the nation's economy or financial systems. But if late payments and foreclosures continue to rise at a faster-than-expected pace, the pain could extend beyond homeowners and lenders to the investors who buy mortgage-backed securities.
Several lenders are already feeling the sting. H&R Block Inc., which operates Option One, a major subprime lender, said last week that its mortgage-services unit posted a pretax loss of $39-million in the fiscal second quarter ended Oct. 31, compared with a year-earlier pretax profit of $48.8-million.
In October, borrowers were 60 days or more behind in payments on 3.9 percent of the subprime home loans packaged into mortgage securities this year, UBS says.
That's nearly twice the delinquency rate on new subprime loans recorded a year earlier.
Fraud has also increased. Some borrowers who took out no- or low-documentation loans were coached by loan officers or mortgage brokers to inflate their incomes and couldn't afford even their first mortgage payment, says Theresa Ortiz, a foreclosure manager with Neighborhood Housing Services of New York, a nonprofit that works with homeowners in financial trouble.
- Subprime mortgages are loans made to borrowers who are considered to be higher credit risks because of past payment problems, high debt relative to income or other factors.
- Lenders typically charge higher interest rates - as much as 4 percentage points more than more credit-worthy borrowers pay.
- Because of that, they are typically one of the most profitable types of mortgages.