The next mortgage mess approaches

We've worried for months now about the next wave of mortgage problems. People who watch this stuff closely say it's approaching.

While it won't be as bad as the wave of delinquencies and foreclosures that crippled home values the past two years, it will still hurt. There's some evidence it may land particularly hard on parts of central Minnesota and some of the Twin Cities far suburbs.

There are a few things going on.

Sources in MPR's Public Insight Network have told us the market's been in a foreclosure lull as lenders hold off on moving against borrowers in default because of the requirements the Obama administration has put on them to try to work things out with the homeowners. That won't last.

There's also a concern that the last chunk of adjustable rate mortgages made while economic times were good and home values were still rising, are about to cause trouble.

These would be ARMs built to reset their interest rates and recast their monthly payments after five years. Think of it as the "deals" from 2005 coming back to haunt in 2010.

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Ed Nelson, a source in our Network with the Minnesota Home Ownership Center told us last summer that we hadn't seen all the foreclosures that will be caused by the Alt-A recasts and the remaining Prime/Alt-A resets that will still happen."

Alt-A mortgages are loans riskier than the highest-quality loans but less risky than sub-prime. "Reset" involves an interest rate change; "recast" is a change in the payment schedule.

Nelson was concerned particularly about interest-only or "pick a payment" loans that would generate a bigger monthly bill for the mortgage holder when the loan reset. Combine that with the jump in unemployment since 2005 and it's a good bet many of those mortgage holders won't be able to make the payments after the recast.

Last week, Nelson posted that the next wave is "rapidly approaching" and cited some eye opening research from the Minnesota Housing Finance Agency, including this map of non-prime adjustable rate mortgages still to reset:

Click on the map for a larger view.

It's fascinating because it shows the potential problems concentrated in some of the farthest reaches of the Twin Cities suburbs and in central Minnesota where lots of larger, expensive homes were built earlier in the decade.

Who are they? My guess is they are homeowners who bought more house than they could afford using an ARM in the far suburbs of the Twin Cities or the lake areas of central Minnesota. We obviously don't know how many of those will turn into defaults but if they now owe more than their homes are worth or if they've lost their jobs, the reset will bite hard.

Jeff Crump, associate professor of housing studies at the University of Minnesota sees high foreclosure rates continuing and agrees the next potential hit may show up in the suburbs.

He cites job loss in the recession, continuing home price declines and "high percentages of Alt-A and other prime products especially in the suburbs. The default rate on these loans is relatively high."

Crump talked about foreclosure this afternoon on MPR's All Things Considered. Click the play button to listen:

Here's a chart from the Federal Reserve Bank of New York's credit conditions site showing the share of Alt-A loans with a late payment in the past 12 months:

On that score, Minnesota doesn't look great with among the highest late payment share between the Rockies and the Appalachians. (The Fed doesn't break out the ARM data by interest-only.)

David Bichanga, a Plymouth Realtor and Network source told us this week he thinks the wave will crash "probably towards the end of 2010" because of the five-year ARMs adjusting and the banks slowing foreclosures from the federal pressure.

"There are also a few cases of home owners just walking away from their homes, home owners intentionally letting their homes go into foreclosure."

There are signs that, maybe, we've learned a collective lesson about mortgage products that seem affordable but really aren't.

Last month, mortgage giant Freddie Mac said it will stop buying interest-only mortgages. That's a big deal and will take much of the shine off of making those mortgages.

But that's a balm for the future. We'll still be dealing with the mortgage excesses of the past awhile longer.

BONUS INFO: Bank of America today announced that it will consider forgiving some debt on some loans that are deeply under water.


Got another perspective? Don't think there's a serious next wave of mortgage problems on the way? Tell us where we're out of line. Post below or contact me directly.