Treasury seeks to stem second wave of foreclosures

The Bush administration acknowledged for the first time yesterday that the mortgage crisis has moved beyond subprime loans as a second wave of foreclosures involving delinquent prime loans looms next year.

The Treasury Department rolled out a program with major lenders to offer a 30-day pause on foreclosures to potentially millions of prime mortgage holders who are delinquent and at risk of losing their homes. Many of these borrowers took out “exploding ARMs” and other exotic loans that are starting to reset at sharply higher payment rates.

The move to try to stem another tidal wave of foreclosures got going early this year as a pattern of problems emerged with nontraditional prime mortgages that looked ominously like the problems that emerged with subprime loans a year ago and led to today’s record levels of foreclosure and default.

“This is a problem that can be foreseen,” Sheila C. Bair, chairman of the Federal Deposit Insurance Corp., testified before the Senate Banking Committee on Jan. 31. “The mortgage servicing industry is facing a wave of impending resets on nontraditional mortgage loans that will begin in earnest in 2009.”

Ms. Bair, who was the first regulator to sound the alarm about the potential for a home-lending crisis three years ago, said that potential foreclosure problems appear to be concentrated in 1.7 million loans worth $600 billion that are often referred to as “Alt-A” because, although the borrowers have prime credit ratings, the loans have features that are riskier than traditional fixed-rate mortgages.

Many of the loans required no income documentation and little down payment or equity in the home, and they enabled borrowers to postpone not only their principal payments through interest-only payment features but to postpone some interest payments as well.

Home buyers in pricey housing markets like Washington’s flocked to these “payment option” loans because the low monthly payments in the first five years enabled them to buy houses whose prices were soaring out of reach as the housing boom progressed.

“These loans became especially popular after 2003 in coastal markets that were seeing large double-digit home price increases,” Ms. Bair said.

But the postponement of substantial parts of the loan obligation set the stage for exploding payments that could as much as double in size once the loans reset.

The most troubling trend is that three-quarters of the borrowers have chosen to make only the minimum payments, Ms. Bair said. That sets them up for the largest possible increases in their mortgage payments when the loans reset, making them unaffordable for most.

The payment-option loans “may expose borrowers to an even greater degree of payment shock” than subprime borrowers experience when their mortgages reset at higher interest rates, she said. Moreover, the millions of payment-option loans resetting next year will require refinancing in “market conditions that may not be much better than we see today.”

A severe tightening of standards by lenders since the fall has led to a paucity of financing options that already is forcing into foreclosure many borrowers who would like to refinance and keep their homes.

Many lenders and mortgage insurers are requiring at least 10 percent down payments on homes, and most have stopped offering subprime and no-documentation loans altogether. Even borrowers with good credit ratings and solid incomes may be unable to refinance if their home value has dropped below the value of the outstanding loans.

In an effort to forestall another wave of foreclosures, five major lenders that encompass 50 percent of the home loan market agreed to offer borrowers a 30-day pause on foreclosure proceedings while they examine ways of refinancing the loans or rescheduling payments.

The homeowners would be able to keep their homes if they pay their refinanced loans or abide for three consecutive months by a repayment schedule worked out with lenders. Lenders participating in the administration’s Hope Now “Lifeline” program include Countrywide, Washington Mutual, Wells Fargo, Chase, Citigroup and Bank of America.

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