Avoiding Foreclosure Starts with Knowing the Road Ahead

Every time I sit down with borrowers here in Seattle, Washington I do my best to educate them to the full future implications of what the mortgage will mean so that they can have the best chance of living happily ever after and avoiding foreclosure. It is clear now that reducing foreclosure starts with proper education and information at the time of loan origination. I am passing information from my point of view across. This is not legal or financial advice and I am not a certified lawyer or financial adviser. 

First some history! When the subprime mortgage crash came many people blamed bad lenders and loan originators for giving bad loans to bad borrowers. However, as a loan originator working with Washington homeowners to keep their houses I realized that subprime borrowers share the same pride of ownership and desire to keep their houses. They are normal people and for the most part they had interest rates around 8% which is the historic national average. They are normal people with normal mortgages.  Subprime borrowers typically had the highest debt ratio and lowest amount of discretionary income.  

When AltA mortgages crashed the same rhetoric was repeated…bad loan originators giving bad (or stated) loans to bad borrowers. However, AltA borrowers typically had far higher credit scores and income then average borrowers.  AltA borrowers typically had an intermediate amount of discretionary income.  

Now, we are seeing a wave of conforming, FHA, and especially conforming jumbo loans begin to default despite the incredible efforts of former President Bush, President Obama, and Congress to aid in loan modifications, refinances, and foreclosure prevention. Conforming borrowers that are foreclosing had good credit and discretionary income. At this point I hope everyone realizes that the rhetoric is just rhetoric. If you apply the rhetoric to say conforming loan borrowers and lenders and loans are bad, then you pretty much pointed the finger at everyone without addressing why. Approximately two thirds of the foreclosures today are on conforming loans.  These are not subprime loans and were not considered risky borrowers. I will go into how and why this is happening so you understand the importance of looking ahead when picking a mortgage.

First I need to explain why the conforming foreclosures are not due to adjustable rate mortgages (ARMs).  Interest rates have held at historic lows for years and most conforming ARMS actually decreased in rate and payments from their initial fixed period.  Conforming ARMs have a margin of ~2.25% which is added to an index (normally the 1 Yr Libor) of 1.49% to end up with a current rate around 3.75%.  This is far below the rate and payments on a thirty year fixed mortgage.  Low interest rates in the last few years resulted in a refinance boom so overall both fixed and adjustable conforming loans are more affordable by themselves then ever.

So why is this new wave of foreclosures happening if the cost of housing is going down?  Well, some minority of people have found themselves so underwater they have given up on their house and walked away.  This is a major source of jumbo conforming loan defaults but not regular conforming loan defaults.  You are reading this to understand and help avoid foreclosure so I am assuming you are not and will not be part of this category.

The majority of these new foreclosures are people who can no longer afford to pay their mortgage.  Here is why. The consumer price index or the cost of goods you normally buy to live has increased around ~3% annually over the last few years while net hourly income has only increased ~0.5% annually so most foreclosures are due people just not having enough income to cover the mortgage and increasing yearly bills.

Figure 1)  Graph of changes in Average Hourly Wage and changes in Consumer Price index from 1999-Current.

As you can plainly see hourly wages are flat and unchanging.  Consumer price costs consistently rises ~3% annually (0.25% per month). What this means is that to plan safely you need to assume over the next seven years total bills will continue to increase by 3% annually while hourly wages remain flat.  This means your bills will likely increase by 20-25% and the increase will not be offset by wages.  The need to plan for the future is at loan origination.     The Consumer Price Index takes into account housing (mortgage) costs.  So while lower rates and housing costs did dip the cost of living earlier overall the combined costs still result in an overall increase of 3% living expenses annually.

This is why subprime borrowers with the lowest amount of discretionary income and highest DTI started a foreclosure wave first, followed by AltA loans, and now followed inevitably by conforming loans. None of the homeowners I have work with want to lose their home, regardless of the loan that they may have.

The second major change is unemployment has roughly doubled from 5% in 2005 to 9.5%.  This does not account for lost pay due to having hours cut.  Unemployment can only be offset by insurance, savings, or investments.

Figure 2)  Rising unemployment from 1999 to current.

So when you pick a mortgage assume your total living costs (including the mortgage) will increase 20-25% over the next seven years.  This may mean that instead of having a higher rate with costs paid for by a lender you may need to pay significant discount costs and possibly buy a smaller house and obtain a smaller loan amount.  In addition it is often wise to pick a thirty year fixed amortization over a fifteen year amortization if the fifteen year payments are close to the maximum you will be able to afford. People who max out on their mortgage by buying the biggest house they can possibly afford are at a very high risk of foreclosure in years to come.  If you find yourself in this situation now it will likely only get worse unless drastic steps are taken.  I strongly suggest financial planning and consulting a loan originator with experience and wisdom.     (Source of data is US Dept. of Labor Bureau of Labor Statistics: http://data.bls.gov)

Stephen Ching is a loan originator working in Washington State.  To contact him regarding questions or comments, or to inquire about a mortgage in Washington State, please visit his site at www.seattle.rateswire.com. He is experienced in a wide range of mortgage services and topics, including purchase loans, refinance loans, loan modifications, and other areas.