A look at the national housing downturn and its affect on the region
Written by Patty Silverstein, chief economist for the Metro Denver EDC, this section identifies major issues affecting the economy and answers frequently asked questions.
A flood of negative news about the national housing downturn and financial markets can produce more questions than answers. Is Colorado really a foreclosure hotspot? Is the worst over? What about home prices and mortgage rates?
Below are several key questions about the housing market and points to keep in mind.
Q: Metro Denver foreclosure filings peaked above 17,000 when housing markets weakened in the late 1980s. In 2007, public trustees recorded 27,356 filings. Does this mean 27,356 Metro Denver residents lost their homes?
A: Foreclosure is a multi-stage process, and each stage involves a “filing” with county public trustees. Specifically, public trustees receive notice of a borrower’s default, the lender’s intention to sell the property, and the lender’s repossession of the property if it fails to sell. In Colorado, public trustees count initial filings, or notices that indicate the foreclosure process has begun. The number of Metro Denver homeowners who ultimately lost their homes, then, is some fraction of the 27,356 initial filings.
Q: Is the current residential downturn worse than the last one?
A: Comparisons of the current housing downturn with the downturn from the late 1980s are inconclusive. Metro Denver public trustees reported 17,122 foreclosure filings in 1988, which amounted to roughly 2.4 percent of the region’s 722,800 occupied housing units.(1) The region’s count of occupied housing units increased to more than one million in 2007, and the 27,356 foreclosure filings for that year represented about 2.6 percent of the total. These figures suggest that the prevalence of foreclosure filings in 2007 is roughly similar to the prevalence of filings in the late 1980s, but the ultimate outcome of the initial filings is not necessarily the same for both periods.
In a different type of comparison, data from the Mortgage Bankers Association National Delinquency Survey show current foreclosure rates below those from the previous downturn.(2) The data was not available before 1990 and do not provide detail for Metro Denver, but show the share of all Colorado loans in foreclosure reached 2.5 percent in the first quarter of 1990. Since the 1980s foreclosure trend peaked in 1988, the foreclosure rate for that year would have almost certainly exceeded 2.5 percent. Colorado’s foreclosure rate was 2.1 percent in the first quarter of 2008, and the national average share of loans in foreclosure was 2.5 percent for the same period. Overall, these results show that Colorado’s current foreclosure rate is lower than the rate from the 1980s and below the current national average.
Q: If only two percent of Colorado home loans are in foreclosure, 98 percent of the housing market should be doing fine. What’s the problem?
A: The geographic distribution of delinquent loans is not even. In fact, the majority of Colorado foreclosure filings are concentrated along the Front Range. According to the Colorado Division of Housing, Colorado’s rate of 2007 foreclosure filings reached one for every 45 occupied households, while the rates in Adams and Denver Counties reached one for every 23 and 32 households, respectively.(3) Metro Denver is not necessarily a foreclosure “hotspot,” but particular communities within the region are struggling with relatively large numbers of distressed homeowners. Further, foreclosures can affect neighboring property values and create challenges for other homeowners who might need to refinance or sell.
Q: The Federal Reserve has been cutting (short-term) interest rates. Will this affect mortgage rates and help borrowers with adjustable rate loans?
A: Changes in the federal funds rate do not directly affect rates for conventional, fixed-rate mortgages. Rather, mortgage rates are set by the bond market, where home loans are often bundled into securities and sold to investors with other long-term instruments. Recent activity in the bond market would theoretically drive mortgage rates down, but some analysts say the risk now associated with mortgage-backed securities is keeping rates high.
The relationship between short-term interest rates and adjustable rate mortgages (ARMs) is somewhat different. The rates on ARMs are partly tied to short-term interest rates, but complex loan terms can make for higher payments even when interest rates decline or stay the same.
The interest rate on an ARM is the sum of a fixed rate (called a margin) and an index, or a measure of short-term interest rates that moves with the market. ARMs originated with discounted – or “teaser” – rates essentially withhold part of a borrower’s full interest rate for an introductory period.
Payments increase when the full interest rate takes effect, even if market rates have stayed the same or declined. Many ARMs also include caps that limit increases in interest rate or payments. Any rate increases that would have applied without the cap can be applied in future resets, and any payment amount in excess of the cap can be added to the balance of the loan. In either case, a borrower’s payments can increase regardless of current interest rates.
Interest-only and so-called option ARMs can also raise payments independent of rates, because many borrowers have been paying little to no principal. Some ARM borrowers may not have understood the terms of their loans, and others may have expected to sell or refinance before their payments adjusted upwards. In many cases, a falling housing market has eliminated those options.
Q: Is the worst behind us?
A: Increased loan delinquency and a weak housing market affect all borrowers and potential buyers, not just homeowners with subprime or adjustable-rate loans. While adjustable rate and subprime loans can be good options for some buyers, a large share of homeowners with these mortgage products can increase a community’s exposure to troubled housing and financial markets.
According to the National Delinquency Survey for the first quarter of 2008, about 20 percent of all U.S. loans outstanding were ARMs. Roughly 12 percent of all loans were subprime, and about 47 percent of those loans were ARMs.(4) Overall, subprime ARMs accounted for 5.8 percent of the U.S. mortgage market in the first quarter of 2008.
Colorado had the nation’s fifth-highest share of ARMs in the first quarter, or 24 percent of all loans outstanding. While subprime loans accounted for 11 percent of all Colorado loans outstanding in the first quarter, a higher-than-average 62 percent of those loans were ARMs. That share ranked fourth-highest in the nation, and Colorado’s share of all loans that are subprime ARMs – 6.7 percent – ranked seventh-highest overall. In general, the data suggest that Colorado communities may be slightly more vulnerable to problems with subprime and adjustable rate loans.
Delinquency is not inevitable for adjustable-rate loans, but ongoing rate adjustments do pose risk. Based on a recent sample of subprime loans, the Federal Reserve Bank of New York suggests that Colorado subprime originations rose sharply in 2005 and peaked in 2006.(5) As of December 2007, 45 percent of more than 38,300 Colorado subprime ARMs in the sample had already had their first reset, and about 34 percent were poised to reset in 2008. The final 21 percent are scheduled to reset in 2009 and 2010.
The data suggest that initial loan resets will continue in the short term, and further resets will occur across the life of adjustable rate loans. The impacts of those resets, however, may not be as severe as the recent disruption. Resources exist to help distressed homeowners negotiate risky loans, and a return to more stable housing and credit markets should give borrowers and buyers better options.
(1) Housing unit estimates from the Colorado Division of Local Government include rentals and other forms of housing not subject to foreclosure, but these homes cannot be isolated from the rest of the data.
(2) Mortgage Bankers Association, National Delinquency Survey, Q108.
(3) Colorado Division of Housing, Fourth Quarter 2007 Foreclosure Report.
(4) Includes prime, subprime, and FHA ARMs but not adjustable-rate VA loans. Data for this loan type were not available.
(5) Federal Reserve Bank of New York, State-Level Subprime Loan Characteristics, December 2007. Data in the report are based on securitized subprime loans only. According to Federal Reserve estimates, these loans represent about half of the subprime mortgage market at the national level. This report assumes the same proportion for Colorado.