One of the great legacies of the housing boom of the past six years is that almost everyone â€“ even people with questionable credit â€“ has access to a mortgage.
But now, some housing advocates contend, all that easy credit is on the verge of creating the worst mortgage crisis since the 1980s. The reason: A rising number of homeowners are shouldering mortgages they can no longer afford. For example:
â€¢In 2004, John Silva refinanced the modest home he and his wife own in Willow Springs, N.C. Today, with their mortgage at almost 10 percent, he worries he's just a "hiccup" away from foreclosure.
â€¢Ten months ago, newly divorced Tammy Myers got a no-down-payment loan to buy a house in Denver. The interest rate is now so high it's difficult to make her monthly payment.
â€¢Susie Smith â€“ a retired social worker who's too embarrassed to use her real name â€“ almost lost the house in St. Paul, Minn., she had lived in for most of her life. That was after she refinanced it and her monthly payments more than doubled from $675 to more than $1,400 a month.
Across the nation, foreclosures and defaults are rising as mortgages that were once affordable are now expensive albatrosses as the introductory "teaser rates" that made the loan possible end and higher interest rates kick in. Some housing specialists worry that the mortgage industry â€“ with more than 20 companies already in bankruptcy â€“ will raise its lending standards so high that would-be homeowners with less-than-perfect credit will be frozen out. There is even some concern that the pullback in lending will extend the slump in the nation's housing market.
"It's the most serious threat to the economy," says Mark Zandi of Moody's Economy.com. "It has the potential to set the housing market back another big notch since there could be a whole class of people who can't get credit."
At issue is a class of mortgages that lenders call "subprime" because they do not qualify for the lowest or prime interest rate. These are designed for high-risk borrowers, those with fixed incomes, or those who have had credit problems in the past. Since 1998, more than 6 million Americans have borrowed in this way, according to the Center for Responsible Lending (CRL). The majority of these loans are adjustable-rate mortgages (ARM) that are tied to changes in interest rates.
That's a dramatic increase in only a decade. In 1995, subprime mortgages represented a niche market: less than 5 percent of mortgages originated. Today, Wall Street analysts estimate they make up from 18 percent to 24 percent.
Advocates contend they've made it possible for millions of Americans who in the past would not be able to qualify for a mortgage to own their home. But critics contend they've also become open to abuse, in part because qualification standards are now so low.
Deregulation has allowed the mortgage industry to create products like the no-down-payment mortgage and the even riskier "no documentation" loan where all borrowers have to do is state their income without providing proof of their ability to repay the loan.
"There was a real rush to make these loans and make as many loans as they could," says Jordan Ash, director of the ACORN Financial Justice Center in Minneapolis, a national low-income housing advocacy organization. "That's because the mortgage companies could sell them off right away" to Wall Street investors.
Investors profited from the high interest rates that consumers were paying.
"Wall Street wanted the mortgage brokers to keep making loans even though they were riskier and riskier," says Ira Rheingold, executive director of the National Association of Consumer Advocates in Washington, D.C. "They didn't care that ... people were getting loans they couldn't afford because there was so much money to be made."
Abuses got so bad that some lenders were making loans to borrowers who ended up defaulting on their very first payment, according to housing experts.
While the housing market was soaring, lenders shrugged off borrowers' problems because the value of the property was rising. But now that the housing market is in a tailspin in some areas, as many as 2.2 million people could end up losing their homes, worth a total of $164 billion, according to CRL. Another report, by Lehman Brothers, concluded that as many as 30 percent of people who obtained subprime loans in 2006 may end up defaulting on them.
"Many families are going to lose their homes," says Deborah Goldstein, executive vice president of the CRL in Durham, N.C. "There's a need for federal regulators to address the kinds of abusive mortgage practices that we're seeing."
Last fall federal regulators started to step in, requiring lenders to disclose more clearly the benefits and risks of some subprime loans to borrowers. On Tuesday, Freddie Mac, a quasi-public backer of home loans, announced it would cease purchasing the riskiest subprime mortgages. This week, Fannie Mae, another quasi-public housing organization, said it is working on "rescue" products to try to help troubled borrowers.
Housing advocates believe the regulators are reacting too late. "They're good positive steps but it's not close to being enough â€“ the genie's already out of the bottle," says Mr. Rheingold. "What we're seeing now with the incredibly high foreclosure rates ... is a product of the complete deregulation of the mortgage industry over the last 10 to 15 years."
The Mortgage Bankers Association (MBA), which represents the nation's major lenders, points out that deregulation has helped create record homeownership.
And the market is already correcting itself, says Kurt Pfotenhauer, the MBA's senior vice president for government affairs. Investors are now requiring stricter standards and mortgage companies are weeding out overly aggressive brokers.
"Government regulation of this market will result in fewer people having access to credit," he says. "If you care about people having access to credit you shouldn't regulate the market."
The catalyst for a lot of defaults will be a change in the interest rates many borrowers pay. This year, holders of some $250 billion in ARMs will see their interest rates rise â€“ perhaps by as much as 1.5 percentage points.
Hugh Moore, an investment manager who runs Guerite Advisors in Greenville, S.C., estimates as many as 1.4 million subprime borrowers will face the prospect of higher interest rates. "I don't know if that constitutes a tidal wave, but you have to believe a number of those people don't have a lot of additional cushion," he says.
Take Mr. Silva's case. In 2004, he was paying 7.6 percent on his $139,000 ARM. Last summer, the two-year teaser interest rate ended and his mortgage jumped 2 percentage points to 9.6 percent. His payments went from $920 to more than $1,200.
The interest on his mortgage, along with his monthly payments, will increase every six months until it reaches a high of 13 percent â€“ if interest rates continue to climb.
"I had wanted a 30-year fixed rate and they told me I'd qualify for one," he says. "Then when I got to the closing they told me I could only qualify for the adjustable rate."
Silva initially walked away. But he had some debts to pay that were due from a stint of unemployment after the dotcom crash in 2000. After two days, he returned and signed the new mortgage.
"I felt like it was a switch and bait," he says.
Ms. Myers is also coping with mortgage sticker shock. As sales director at a Colorado golf course, her commission-driven income depends on weather. When she got her no-down payment loan last spring, costing $2,200 a month, the weather was good and she was bringing home as much as $6,000 a month. When snow came early to Denver, the golf course closed, and her monthly income has plummeted to $2,200 â€“ only enough to cover the mortgage and nothing else. She's maxed out her credit cards and borrowed from family to make payments over the last few months. Her March payment is now due and she only has $1,000 left in the bank.
"They won't take a partial payment, and they say they won't work with me until I've been 60 days late on my mortgage," she says. "I've never been late before, and I don't ever remember being in a financial situation like this before."
Ms. Smith nearly lost her St. Paul house to foreclosure. A retired social worker on a fixed income who is raising a grandson on her own, she had no intention of refinancing her 30-year fixed-rate mortgage. Then her insurance company said her old house needed structural repairs â€“ and it wouldn't issue a policy until the work was done. That's when a mortgage broker came around. He told her he could get her an adjustable-rate mortgage that would allow her to take out equity to pay for the repairs without increasing her monthly payment too much â€“ at least for the first two years. When she asked what would happen after the two-year "teaser rate" was up, the broker told her she could just refinance again.
"And voilÃ , at the end of the two years, I get this slap in the face â€“ they start raising the interest rates every few months and said, 'No, we're not going to refinance,' " she says. Eventually, her payments doubled to more than $1,400 a month. "I told them I don't make $1,400 a month," she says. "'Tough,' they said, 'It's just too bad.' "
Eventually, the lender started foreclosure proceedings. Smith then contacted ACORN, the national housing organization, which negotiated a new fixed-rate loan for her. But her payments are still more than $1,300 a month and she's now working as many part-time jobs as she can find.
"I hate for anyone to find out that I was this stupid, that I could get caught up in something like this," she says. "The sad thing is that I'm not the only one. There are thousands of people that this is happening to."