E-mail this page Reader Comments (below)

By EDWARD D. MURPHY, Staff Writer Sunday, January 7, 2007

A financial research group is predicting that foreclosures on homes carrying subprime mortgages in southern Maine will accelerate in coming years -- with the rate nearly tripling and reflecting a national leap in foreclosures for borrowers with poor credit.

The Center for Responsible Lending projects that 17.8 percent of subprime loans taken out last year in the Portland-Biddeford region will end in foreclosure and the lender selling off the home. That's an increase of nearly 160 percent over the group's estimate that 6.8 percent of subprime loans taken out from 1998 to 2001 in southern Maine have or will end up with the loss of a home to the lender.

CRL based its projections on an analysis of subprime mortgage foreclosure patterns and forecasts of housing appreciation. The organization's report, "Losing Ground," predicts that, nationally, 2.2 million borrowers who took out subprime loans in the last nine years will lose their homes through foreclosure, wiping out $164 billion in wealth.

"There should be a restoration of common sense," said Uriah King, policy associate at CRL. "We can't let this purging of homeowners continue."

Subprime mortgages are riskier loans made to borrowers with poor credit scores, low income compared to the size of the loan or spotty payment histories.

Instead of financing through a bank, subprime mortgages often come from lending companies such as Ameriquest or New Century. The mortgages carry higher interest rates than loans for borrowers with more solid finances and are often more complex, with features such as variable-rate loans that start with low initial interest rates that balloon after a few years, interest-only mortgages that leave the principal undiminished for several years or high penalty charges for early payoffs.

CRL is projecting that 19.4 percent of all subprime mortgages taken out in 2005 and 2006 will end up in the loss of the home due to foreclosure and liquidation. Southern Maine's rate is lower than that national figure, but the pace of the predicted increase in foreclosures on recent loans, compared to those made five to nine years ago, is the 40th fastest out of 378 metro areas studied.

A key reason for the increase is the sluggish real estate market. Those who hold older loans have a better opportunity to refinance to avoid foreclosure because their homes have likely gained in value since the mortgage was taken out, making lenders more willing to extend credit.

Those who borrowed to buy a home or refinance last year won't be able to easily refinance or tap into equity gains because house values in the region have, at best, leveled off in the last few months.

Refinancing has been the busiest sector of the mortgage market as home values have shot up over the last decade. Homeowners who have refinanced have been able to pull out equity -- the difference between a house's value and the amount owed on the mortgage -- and many have also been able to lower their payments because interest rates plummeted for three years following a national recession in early 2001.

In the subprime market, refinancings are used mostly to consolidate debt, avoid higher interest rates or catch up on late mortgage payments. A substantial number of subprime mortgages are paid off while the borrower was behind in payments, indicating it was paid as a result of a refinancing, the CRL report said.

Nationally, of subprime loans that originated in 2000, nearly half have been delinquent at some point and 22.9 percent of the borrowers were so far behind they received foreclosure notices, the report said. Nearly 13 percent were actually foreclosed on and 11.1 percent were prepaid "in distress," or while behind in payments, according to the report.

In Maine, 20.9 percent of subprime loans that originated from 1999 to 2005 entered the foreclosure process, a study by Coastal Enterprises Inc. found, although there are no figures on how many of those were actually taken by lenders, said Carla Dickstein, a senior program officer for the organization.

"These are lives of millions of people. What are they going to do and what is it going to do to the community?" Dickstein said, referring to national foreclosure figures. "It's a proliferation of people who should never be in these loans."

'HOUSE OF CARDS'

That view is echoed by King at CRL.

He said subprime loans are lucrative for mortgage brokers who specialize in the market because they charge high fees up-front. The lenders then bundle the subprime loans with more solid financing and sell the mortgages in a secondary market that deals in transactions measured in billions of dollars.

So a proliferation of foreclosures, King said, could impact the entire economy.

"What's going on in the mortgage industry, particularly the subprime, is a house of cards," he said.

Beyond the financial markets that would be hurt by a wave of foreclosures, it would also put more houses on the market, further depressing values in individual communities, he said.

King said there are reasons beyond flattening property values that will increase the pace of foreclosures.

Subprime loans, already risky to begin with, have become even riskier because unscrupulous brokers have incentives to close a loan -- earning their commission -- and none in making sure the mortgage can be repaid. Lenders also have more products to push that result in artificially low initial interest rates and don't factor in whether a borrower can keep up once the payments jump.

King said one of the most popular loans in the subprime market is a 2/28, which means two years of a low "teaser" rate, followed by 28 years of higher variable rates that can be adjusted every six months.

He said a typical loan might carry an initial interest rate of 7.5 percent, but that jumps after two years. The variable rate is usually based on financial indexes, such as the prime interest rate or some other measuring stick, plus a spread. Currently, that would mean a typical adjustable rate is more than 12 percent for most subprime loans.

Jennifer Waite, a Millinocket hospital worker, knows first-hand how those mortgages work.

About four years ago, she took out a $64,000 loan to buy a home for herself, her disabled husband and their two children. Her interest rate was 8.25 percent, fixed for two years, and she paid about $7,500 in points and fees at closing.

After the fixed rate expired, her interest rate began jumping every six months and was soon near the ceiling of 14.75 percent. Her $516 monthly payment shot up to $900 and she soon was behind on her other bills.

"We couldn't hold out much longer," Waite said, explaining that the couple wasn't able to afford needed repairs to the roof and furnace. "I was about to take the keys and mail it to them."

Waite said she never received a foreclosure notice, but was sure one was coming until she was able to refinance through a private community development agency, Penquis CAP. She now has a 30-year mortgage with a 7.25 percent fixed rate.

"Virtually no one can handle the payment shock," King said, pointing out that many subprime borrowers are already allocating about half their income for mortgage payments -- before the rates jump.

For many subprime borrowers, the only option has been to repeatedly refinance in order to gain another few years of lower interest rates. But that also means another round of fees for mortgage brokers, closing costs and sometimes a penalty for paying off the first mortgage ahead of schedule. The borrower ends up deeper in debt, rather than escaping it, and the option is disappearing with flat home values.

"These are people who are in a difficult spot to begin with," King said. "It's only a matter of time before that family collapses."

Another factor behind rising foreclosures is that underwriting -- making sure a borrower has the means to pay back the loan -- has become lax, King said.

He noted a CEI study that found that 40 percent of subprime loans in Maine were made without verifying the income claims of the borrower. Since borrowers will sometimes inflate incomes and since most subprime debt-to-income ratios don't factor in the cost of property taxes and insurance, "we've got a recipe for disaster," King said.

Because housing prices aren't rising and the loans are based on the value of the house, it's more difficult for many borrowers to refinance now, King said. That's why the CRL is predicting a higher rate of foreclosures for loans made recently than for those taken out seven or eight years ago.

REGIONAL DIFFERENCES

It also explains a difference between the predictions for foreclosure rates in central and northern Maine, compared to southern Maine, Dickstein noted. She said housing prices in the Bangor and Lewiston/Auburn regions didn't rise nearly so much as those in southern Maine, so borrowers there probably won't face a sharp drop in home values. Foreclosure rates in those areas, which were double or more those for the Portland region on subprime loans made from 1998-2001, are actually expected to drop for loans made in 2006.

King said those figures reflect a report by CRL's consultants that land values in the Lewiston area will be stable and those in Bangor will increase in the next few years.

Statewide, CRL said, 8.5 percent of subprime loans made from 1998 to 2001 are likely to end up in foreclosure and liquidation, but that figure is predicted to rise to 16.4 percent for loans taken out last year.

CEI wants Maine to adopt several measures to help homeowners in the state avoid being caught up in foreclosures and most of its recommendations are included in a bill submitted by Rep. Glenn Cummings, D-Portland, the speaker of the Maine House.

The changes include protections that kick in once fees and points exceed 5 percent of the loan's value, instead of the 8 percent trigger currently in the law. Borrowers would have mandatory credit counseling, while prepayment penalties and "yield spread premiums" -- essentially a bonus paid to the broker who closes on a high-interest rate mortgage -- would be banned for loans with high fees and costs.

The bill would also require that mortgage brokers ensure that the borrower is getting a tangible financial benefit out of refinancing, rather than just generating more fees for the broker. And the measure would ban mandatory arbitration of disputes between the borrower and lender, allowing borrowers to go to court, and would require the eventual buyer of the mortgage to make sure the laws were followed.

Other states have similar laws, King said, and "in the long run, it will make homeownership stronger and more sustainable."

Cummings said his goal is to remove some of the tactics that predatory lenders use, but without shutting down the subprime market.

"There's a very legitimate place for subprime lending, but what there's not a place for is misleading and deceptive practices," Cummings said. Without more protection, "it's a competitive disadvantage for responsible lenders," he said.

"This is another thing that adds to the difficulty of Mainers in keeping their homes," Cummings added. "In this state, where a sense of community is important, when you lose a home, you lose a piece of that community."

Staff Writer Edward D. Murphy can be contacted at 791-6465 or at: