Home Losses Loom

Home losses loom

But experts are divided over how hard a mortgage foreclosure wave would hit region

By Jim Wasserman - Bee Staff Writer

Published 12:00 am PST Sunday, January 28, 2007
Story appeared in BUSINESS section, Page D1

James and Beth Fullenwider are living inside a bad dream growing ever more familiar across the Sacramento region: Their 2,400-square-foot house in Elk Grove is slowly slipping away from them.

They can't afford their $3,300 monthly payment.

"If the credit people had really looked at our situation, they would have laughed and said, 'You can't come close to qualifying for this,' " says James Fullenwider, who runs a video production business at home. “We're in a house we have no business being in."

He says the couple didn't read the home loan's fine print. Only after moving into the $500,000 home last August did they learn the loan agent inflated their income to qualify them for the financing. "But we were stupid to do it," Fullenwider says.

The couple's story illustrates one of the biggest questions hanging over the Sacramento region's real estate market this year. As housing prices search for bottom, some financial experts fear that a multitude of expensive and newly adjusting mortgages have the potential to spark a rising tide of foreclosures. That, in turn, could be a hidden time bomb, shoving more homes onto the for-sale market and further stressing a downturn already well into its second year.

What actually will happen is anything but clear. Late mortgage payments and foreclosures, while rising, largely remain below levels of the region's 1990s recession-driven housing bust. Yet, the repercussions from a boom fueled in large part by cheap money and easy credit can't be ignored.

Adjustable rate loans became the dominant form of financing for people who otherwise could not have afforded their homes during the rapid price escalations that marked the boom.

The loans offer low initial payments that eventually reset to higher interest rates and often much bigger monthly payments.

Nearly $1.3 trillion in adjustable rate mortgages -- ARMs -- will reset to higher payments this year, according to mortgage giant Freddie Mac and other financial institutions.

That will cause some payments to rise $200 a month. Others will double or triple.

In markets like Sacramento, already heavy with excess resale inventory, some speculate that stressed owners will hand more homes back to banks and aggravate the oversupply. Since the high inventory of houses for sale already is depressing prices, a run of foreclosures would likely further depress them.

New statistics indicate foreclosures are rising fast. Last week, La Jolla-based DataQuick Information Systems reported 865 foreclosures in Amador, El Dorado, Nevada, Placer, Sacramento, Sutter, Yolo and Yuba counties during the fourth quarter of 2006, nearly doubling from the previous quarter.

DataQuick also reported 3,071 notices of late mortgage payments -- known as notices of defaults -- during the same period. While that was a 16 percent increase over the previous quarter, the rate of growth had slowed somewhat from earlier in 2006.

Economists say areas like the Central Valley that had an explosion of new houses and now wrestle with falling home values are particularly vulnerable to "payment shock." Many ARM borrowers owe more on their loans than their houses are worth. They can't sell and they can't refinance into cheaper loans, which raises their risk of foreclosure.

"For people in adjustables especially, if they owe more than their house is worth, they're going to have little reason to stay and kill themselves to make that mortgage payment," says Vicky Henderson, senior loan consultant at Sacramento's Vitek Mortgage.

But other real estate analysts still believe the foreclosure phenomenon will be more of a ripple than a 1990s-style wave.

DataQuick analyst John Karevoll says the slowdown in growth for notices of defaults -- the first step toward foreclosure -- indicates the largest share of potentially troubling loans is moving past its riskiest time frame for problems. Karevoll said last week the region "may have seen most of the surge it's going to have in (notices of) default activity."

Others cite steady job growth and relatively low interest rates that have allowed many borrowers to refinance out of their ARMs. And experts such as Alexis McGee, president of Fair Oaks-based ForeclosureS.com., believe banks' deep pockets will stop them from dumping excessive numbers of repossessed houses onto the market at once.

Christopher Cagan, who analyzes financial trends at Santa Ana-based First American Real Estate Solutions, predicts 21,420 foreclosures during the next five years among ARM holders in El Dorado, Placer, Sacramento, Sutter, Yolo and Yuba counties. That's 16.9 percent of the 126,000 ARMs used for home purchases and refinancings in 2004, 2005 and the first half of 2006.

"Adjustables generally have higher default rates than fixed, particularly those taken out near the top of the market cycle," he says.

Yet Cagan maintains that those defaults -- while extremely painful to those involved -- represent only a tiny slice of the overall economy.

"I think this is going to be long and drawn out," he says. "If somebody faces a reset in 2007, often it takes a year to lose the property. A lot of lenders will work with you. They don't want to be stuck with the property in a difficult market."

Like all of California, Sacramento-area homebuyers have grown dependent on adjustable rate financing to buy houses that more than doubled in value since 2000. In 2004, about 65 percent of homebuyers in Amador, El Dorado, Nevada, Placer, Sacramento, Sutter, Yolo and Yuba counties used adjustables. The next year, the total jumped to 73 percent before falling back to 62.5 percent from January through November 2006, according to DataQuick.

That's about 135,000 ARMS in the last three years, with thousands of them adjusting upward in 2007, according to San Francisco-based Loan Performance, which tracks mortgage risk data. Data-Quick analysts said thousands more used ARMS in refinancing loans.

Loan Performance, which tracks U.S. mortgage industry loans, estimated that nearly half of 2004 and 2005 homebuyers in the eight-county region used interest-only loans. Those let borrowers pay only the interest portion for a specified number of years, then hike payments to cover principal, as well.

The firm estimates that in 2005 as home prices peaked, nearly one in five borrowers used even riskier Option ARMS. Those loans let buyers choose from a variety of payment options -- including a minimum payment that doesn't cover the cost of interest. In the first nine months of 2006, one in four Sacramento-area borrowers were using them, Loan Performance estimated.

Those kind of loans will spell trouble later this year when some borrowers face skyrocketing payments, said Bob Walter, chief economist of Michigan-based Quicken Loans.

"Seventy-five percent of the people who take those make the minimum payment," he said. "If you make the minimum payment, about the third year, about the 36th to 38th payment, it nearly triples. Most people will adjust out of them, but the ones in financial difficulty are the ones who will get caught."

For now, economists like Keitaro Matsuda of San Francisco-based Union Bank of California, see low interest rates, job growth and a strong state and Sacramento-area economy overriding any rise in foreclosures.

"I agree that the foreclosures will be a fact of life moving forward and will play some role," said the bank's senior economist. "But I don't think that in itself it can move the market as significantly as in the 1990s. The reason is the economy here in California is on much firmer ground than we were in the '90s."

The Fullenwiders, who received an interest-only loan, considered walking away from the house and becoming a foreclosure statistic. But real estate agent Mike Toste of Antelope is trying to save them with a short sale. That's a tactic in which he finds a buyer for the home and persuades the bank to accept less than it's currently owed.

If he can do that, the Fullenwiders will escape with less damage to their credit than a foreclosure.