An explosion in overdue mortgages tailored to home buyers with less-than-sterling credit has driven foreclosure filings to record highs in Massachusetts.
These mortgages, known as subprime loans, charge higher interest rates to compensate the lender for the risks associated with customers who have low credit scores or large credit card or other debts.
Subprime mortgages were lauded for helping more Americans than ever buy homes during the housing boom earlier in the decade. But four years after their popularity took off, the loans are backfiring. More homeowners are no longer able to afford their payments, which typically rise sharply two years into the loan. In 2006, lenders filed 19,487 foreclosure notices against Massachusetts homeowners, surpassing the record high of 17,000 filings in 1991, during the state's severe recession.
New research by the Federal Reserve Bank of Boston on the rising tide of foreclosure filings in the state found that subprime loans are a major culprit. While subprime loans make up 12 percent of all mortgages in the state, they accounted for more than two-thirds of foreclosure filings in the third quarter of 2006, the most recent data available . Most delinquencies were high-interest subprime loans with adjustable rates, which increase payments as interest rates rise. Homeowners hit the hardest were in the working-class cities of Brockton, Springfield, Lawrence, Fitchburg, and Lowell, the Fed said.
The trend is very disturbing, said Richard Walker, Boston Fed vice president. "We're monitoring it closely."
Historically, only one in four homeowners threatened with foreclosure actually loses a home. Foreclosure is a legal process that takes six months to two years from the initial filing to the sale of the home in an auction. Most homeowners either renegotiate a payment plan with their lender or sell their house to pay off the loan. But when home values decline, as they did last year, the options become limited.
Tammy Amado obtained two mortgages to buy her Dorchester two-family home in January 2005 from Fremont Investment & Loan, a subsidiary of California-based Fremont General Corp. and one of the largest subprime lenders in Massachusetts. Despite having a good job as an apartment manager, she fell behind on her payments. "I'm trying the best that I can," said Amado, who found a second job last year as a tax specialist.
The interest rate on the bigger loan, for $380,000, was initially 6.4 percent and would rise after two years, according to her loan documents; a second, $89,000 loan had a permanent 11 percent rate. (The rate for a 30-year, fixed mortgage was 5.7 percent at the time.) Her combined monthly payment: $3,225, the documents show. Amado said she paid her mortgage the first year and landed a tenant for the rental unit, but her budget became strained when her 11-year partner -- father of two of her three children -- moved out more than a year ago and stopped contributing to the mortgage. Fremont declined to comment on Amado's loans.
A Jan. 6 letter from the company servicing her mortgage said the rate on her mortgage was scheduled to increase March 1 to 9.4 percent, pushing her payment up $755. Based on 2006 income of $45,519 on Amado's tax documents, her loan "probably would've become problematic" even with her partner's help, said Jason Wheeler, national refinance director at Neighborhood Assistance Corp. of America, a nonprofit housing advocate. Amado applied to the agency for an affordable, fixed-rate mortgage to refinance her loan and save her house.
Michael Fratantoni, chief economist for the Mortgage Bankers Association in Washington, said the foreclosure problem hasn't reached a crisis and will not affect the national housing market or the economy. And he cited specific local conditions for a spike in filings. "Massachusetts' job growth rate is lower than nationally," he said, adding that "home prices there declined while nationally home prices are still growing."
"You would expect Massachusetts to look worse, particularly among borrowers with credit problems," Fratantoni said.
But the increasing number of homeowners who have fallen behind on their mortgage payments has recently roiled the industry. At least 20 US lenders went out of business or were sold since the start of 2006. Last week, Freddie Mac, a major source of US mortgage funds, toughened its standards for purchases of subprime loans. Subprime players include subsidiaries of corporate giants such as London-based HSBC Holdings Plc, Citigroup, and Wells Fargo amp; Co., and independent companies such as New Century Financial Corp. HSBC said recently that the rising numbers of delinquent subprime borrowers would hurt company earnings, and New Century's stock dropped by half this month after the California lender predicted a loss in the final quarter of 2006 from rising defaults.
Fremont Investment Loan last week said it expected to report a loss in the most recent quarter because of bad loans and said it might sell its subprime business.
"Wall Street encouraged these loans to be made, and it looks like homeowners are paying the price, and it looks like investors may pay the price," said James Campen, economics professor emeritus at the University of Massachusetts at Boston. Campen said that HR Block Inc.'s subsidiary, Option One Mortgage Corp., joined Fremont as the largest subprime lenders in the state.
The rise of subprime lending to a $640 billion business annually marks a dramatic change in the mortgage industry. In the past, home buyers applied to a bank, and either they qualified for a traditional 30-year loan or they were turned down. Those who qualified received a standard interest rate. Today, credit is easier to obtain from a broad range of poorly regulated mortgage companies -- but at a price. Prospective customers with poor credit ratings can choose from various mortgage products, but the interest rate and fees are much higher because of the riskiness of the loans.
"This is a whole class of mortgages that have never been tested in a down market," said William Apgar, senior scholar at Harvard University's Joint Center for Housing Studies. "There's a potential for quite a dramatic increase in foreclosures."
The Federal Reserve Board and other regulators issued a warning Friday, expressing concern that subprime borrowers "may not fully understand" their loans.
Bard Conn, Boston senior vice president for Countrywide Home Loans, a subprime and conventional lender, said the mortgage business is highly competitive and borrowers have alternatives they may not be aware of.
While more homeowners are in financial distress, the share of Massachusetts homeowners late on their house payments remains below the national average. Less than 1 percent of the state's mortgages were in the foreclosure process last year, compared with more than 1 percent nationally, the mortgage association said. But state foreclosures are "going up faster" and the gap is narrowing, said Julia Reade, the Boston Fed senior research associate who prepared the report. "Certain neighborhoods are being hit really hard but don't show up in the aggregate data."
Since 2003, Brockton's foreclosure filings have tripled. Chief assessor Bernie Siegel partly blames subprime lenders for a 10 percent slide last year in Brockton house prices. The high-cost loans are clustered in minority neighborhoods, he said.
First-time home buyers who get subprime loans don't understand the ramifications of homeownership, he said. "It just becomes too much."
Kimberly Blanton can be reached at email@example.com.