A new threat is emerging that could keep the tidal wave of foreclosures continuing into 2011, experts say.
More interest-only and so-called option adjustable-rate mortgages handed out during the real-estate boom -- loans considered a step up from subprime that were intended for borrowers with higher credit scores -- are starting to go bad as home values continue to fall. These loans also are called alternative-documentation loans, or Alt-A.
Subprime loans, often with adjustable rates, blew the bottom out of home prices beginning last year and sent a flood of bank-owned homes on to the real estate market after many borrowers found they couldn't keep up with escalating payments.
The same thing could happen with Alt-A loans, many of which will "recast" -- or adjust upward -- beginning next year. Defaults are expected on interest-only mortgages because the borrower pays only interest for a period of time, usually five or seven years. Then the remaining balance must be paid over a shorter term, which increases the monthly payment -- especially if the loan features an adjustable rate.
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Because the loans were selling like hotcakes in the early part of the decade, many are coming due in the near future, experts say.
The loans were popular in the central San Joaquin Valley as housing prices soared during the real-estate boom. Borrowers expected to refinance before their payments increased. Instead, home values fell, borrowers owed more than their houses were worth, and new loans weren't possible.
"I got caught with my pants down on quite a few," said Richard Barnes, owner of Resource Lenders of Fresno, who issued those types of loans.
Alt-A loans will begin recasting this year, said Paul Leonard, director of the California office of the Center for Responsible Lending, which works to eliminate predatory lending practices. The adjustments are expected to continue at a high level through 2010 and then begin to decline, he said.
The result is likely to be more homes pushed on to the market through foreclosure, said Sean O'Toole, president of ForeclosureRadar, an online tracking service.
Whether another wave of defaults would continue to send values down remains to be seen, he said.
Prices likely won't increase if supply vastly surpasses demand, but they will only fall so far before hitting a natural bottom, he said. California's growth rate, rental rates, construction costs and income levels help determine that level, and O'Toole said he thinks some communities, such as Stockton, which leads the nation in foreclosures, might already be near the bottom.
Don Scordino, president of the Fresno Association of Realtors, said real estate agents are seeing more activity as lower prices draw people into the market. His association doesn't track Alt-A loans, but he said most agents think that the market is experiencing the worst of the foreclosure crisis now.
During the most recent quarter, foreclosures made up 43.2% of all sales in Fresno County, up from 6.3% five years ago, according to Zillow.com, an online service. The median home price of $204,000 is off 22% from last year, according to Zillow.com, and about 80% of all homeowners who bought in 2006 are under water.
The California-based bank IndyMac and other Alt-A lenders already are experiencing large losses. Freddie Mac, which purchases mortgages from other financial institutions, is reeling from the loans. They make up 10% of Freddie's portfolio but accounted for more than half of the company's credit losses in the second quarter of this year.
How many borrowers will wind up losing their homes remains to be seen. Last quarter, only 25% of borrowers in California who defaulted on their mortgage escaped foreclosure, down from 80% in summer 2006.
But new legislation and increased willingness by banks to work with borrowers could help.
"We do see modest increases in [loan] modifications occurring, which I think is stunning," Leonard said. "But it is not keeping pace with foreclosures and defaults."
Last quarter, there were 120,000 more foreclosures than modifications in California, the Center for Responsible Lending said.
O'Toole of ForeclosureRadar.com said the problem is too big to bail out. He said he thinks the government measures mostly postpone the inevitable.
But he also issued an encouraging message. Falling prices are sparking an increase in home sales, which is a first step toward recovery.
The population in California continues to grow, the cost of building a house is increasing and housing prices won't fall below a certain level, O'Toole said.
Prices aren't likely to increase for at least two years, he said, but eventually they will.
"Time will fix everything," O'Toole said. "The real question is when, and that is what we don't know."