Rhode Island homeowners, lenders skirt default

Rolando Ruiz and Stephanie Rodrigues telephoned their mortgage lender two weeks ago and offered to hand over the keys to their three-bedroom house in Providence, R.I.. They lost their jobs and haven't made a loan payment since January.

"I told the bank to come get the keys and just let me know when we need to be out, but they said why not put it up for sale and we might be able to work something out," said Rodrigues, the 22-year-old mother of two girls.

Homeowners such as the Rhode Island couple are finding their mortgage companies eager to accept a sale price that falls short of a property's loan balance -- a so-called mortgage short sale. The number of U.S. loans entering foreclosure reached an all-time high in the fourth quarter, according to the Washington-based Mortgage Bankers Association. That's spawning a cottage industry of real estate investors who profit as lenders try to avoid adding properties to their portfolios.

"Banks don't want to be real estate managers," said Doug Duncan, chief economist of the mortgage association. "The fact that delinquencies are rising means we're going to see more pre- foreclosure sales."

Almost 5 percent of U.S. mortgages had payments overdue by 30 days or more at the end of last year, the highest since 2003, Duncan said. No one tracks or estimates the number of borrowers who avoid foreclosure with a short sale, according to Duncan and David Berson, chief economist of Washington-based Fannie Mae, the largest buyer of mortgages. There's ample evidence that the number is increasing, they said.

"Clearly it's happening and the numbers are rising," Berson said. "What we need to know to be concerned is how it compares to the last cycle, but no one tracks that."

The short sales may mitigate the impact of the housing slump as the properties avoid being tallied as foreclosures. At the same time, they will help push the U.S. median home price to a third consecutive quarterly decline in 2007's first three months, Berson said.

"The way the banks see it, it's better than if the house goes into foreclosure, stands empty, and sees its value spiral downward before it's auctioned on the courthouse steps," Duncan said. "It helps to clear the market."

Both sides benefit from the transaction. Lenders absolve a portion of the mortgage and don't end up owning property. Although borrowers lose their homes, they avoid the stigma of default, making it more likely they will buy another property in the future.

Overdue payments, or delinquencies, on all types of loans in the fourth quarter rose to 4.95 percent, almost half a percentage point above the 4.47 percent average of the previous three years, Duncan said.

Late payments by subprime borrowers, those with tarnished or insufficient credit, climbed to 13.3 percent, compared with 2.57 percent for prime mortgages, according to a report released last week by the bankers' group. Foreclosures on prime mortgages rose to 0.5 percent from 0.42 percent a year earlier, a sign of broader trouble in the mortgage market.

In the U.K., where real estate prices are rising, the number of mortgages with payments between three to six months late slipped to 59,100, or 0.5 percent, in the second half of 2006 from 62,920, or 0.54 percent, a year earlier, according to the London-based Council of Mortgage Lenders.

As a growing number of U.S. borrowers were unable to pay their loans, more than 30 subprime lenders have closed since late 2006, according to a March 16 report from Newport Beach, California-based Pacific Investment Management Co.

Wells Fargo & Co. and National City Corp. face the most risk among the largest regional banks from rising defaults by subprime borrowers, analysts at Merrill Lynch & Co. wrote in a report last month. About 12 percent to 14 percent of San Francisco-based Wells Fargo's total loans outstanding and 8.5 percent of Cleveland-based National City's were made to subprime borrowers.

Merrill estimated that subprime holdings at Bank of America Corp., U.S. Bancorp, BB&T Corp. and Wachovia Corp. were 3 percent to 5 percent.

The situation has provided plenty of opportunity for property investors like 30-year-old Dallas Alford of Wilmington, North Carolina. Business is booming, he said.

"Lenders have become more forgiving in the last few months because defaults are rising, and they're not in the business of owning houses," Alford said. "Trying to put that kind of deal together a year ago was a waste of time because banks weren't interested in a buyback."

Alford said he handles about three or four mortgage buyback transactions a month with lenders usually forgiving $30,000 to $40,000 per loan. He declined to identify the banks involved.

In a typical deal, Alford finds a homeowner who has lost a job or had a business fail and gotten behind on his mortgage payments. He might be willing to pay $205,000 for a house that has a $235,000 mortgage, which would require the lender to forgive $30,000 of the loan.

Historically, only about 25 percent of mortgages that are delinquent end up in foreclosure. Some are resolved through a short sale and others result in a "deed in lieu of foreclosure" in which the owner surrenders the deed without a foreclosure and the bank ends up as a property owner.

In contrast, almost all mortgage forgiveness involves the sale of the property, said Regan Brewer, a counselor at Acorn Housing, a Chicago-based consumer group that provides free housing counseling to low- and moderate-income homebuyers. It's not likely a bank will reduce the loan's principal just because a house has fallen in value. In rare cases, borrowers can negotiate with banks to reduce late fees and charges that have been added to their loan's balance, Brewer said.

About three-quarters of the 400 homeowners who have visited the Acorn Housing office in Chicago in the past two months have been subprime borrowers who can't make their mortgage payments because their loans are resetting at higher rates, Brewer said. Some subprime loans reset every six months, she said.

"I don't know too many people who can afford to see their mortgage payment go up $400 or $600 every six months," Brewer said. "Most people don't have the income to keep up with that."

Borrowers who run into trouble paying their mortgages have fewer options in today's market, compared with a few years ago.

During the five-year housing boom that ended in 2005, owners who fell behind on payments could sell their homes and pay off their loans or get better refinancing terms based on the higher value of their property.

That's what Ruiz, a truck driver, and Rodrigues, a bank customer-service worker, said they hoped to do. The first-time buyers paid $195,000 a year ago for an eight-room house and spent about $12,000 renovating it.

Ruiz, 33, lost his job driving an appliance delivery truck in November. Rodrigues lost her job at Bank of America in January. They found they couldn't recoup the money they put into the property because real estate values in Providence had fallen. The city's median selling price declined 1.1 percent in the fourth quarter to $291,300 from $294,400 a year earlier, according to the Chicago-based National Association of Realtors.

"If the market had kept rising, we would have been fine because we could have easily sold for a profit when we lost our jobs," said Rodrigues. "Now, we're in a jam."

Home prices fell in about half of U.S. cities in the fourth quarter, according to the realtors association. The national median price for a previously owned house was $219,300 in the fourth quarter, down 2.7 percent from a year earlier, the Chicago-based trade group said in a Feb. 15 report.

About 15 percent of U.S. banks tightened underwriting standards in the fourth quarter, making it more difficult for people to qualify for mortgages, the Federal Reserve's Senior Loan Officer Survey reported in January.

That action came too late, said Jonathan Werner, a real estate investor in Livonia, Michigan, who negotiates buyback deals with homeowners and banks.

"A lot of people have over-borrowed to pay high home prices, and lenders pushed crazy loans on people they knew probably couldn't pay them back," said Werner.

Werner said he's so overwhelmed with calls from homeowners who want a quick sale rather than a foreclosure that he no longer needs to advertise in newspapers for customers.

Most of his clients live in Wayne County in southeastern Michigan, which ranked first in the U.S. for foreclosures in 2006, according to Realty Trac, an industry Web site. The county has 33 towns and cities, including Detroit, and a population of 2.1 million, making it the largest in the state.

Subprime mortgages have rates that are at least 2 or 3 percentage points more than safer prime loans. About 20 percent of all new mortgages made last year were to subprime borrowers, according to Duncan of the mortgage association.

Some subprime borrowers were given loans without income verification at rates that probably will jump to levels they can't afford, said Federal Reserve Governor Susan Bies in a Feb. 20 speech at Duke University's Fuqua School of Business in Durham, North Carolina.

"Products that had adjustable payments every month began to be mass marketed to subprime borrowers, and we found that there was just stated income, no testing of income," Bies said. Borrowers "did not have the ability to absorb the higher payments when the payments started shooting up."

While the loans may have looked good on the books during 2006, many of them haven't performed well. Countrywide Financial Corp., the biggest U.S. mortgage lender, said payments at the end of 2006 were late on almost 20 percent of the subprime loans it tracks for other companies and investors who own them.

The situation may get worse, Bies said in a March 9 speech at a risk-management forum in Charlotte, North Carolina.

"What's happening is the front end of this wave of teaser- rate loans that are coming into full pricing," Bies said. "So what we're seeing in this narrow segment is the beginning of the wave. This is not the end, this is the beginning."

It's a beginning of a different sort for Rodrigues and Ruiz, the Providence homeowners. Before they lost their jobs, they were earning about $5,000 a month, Rodrigues said. Now, they take in about $800 in unemployment benefits, and they're getting ready to move.

"It looks like we're going back to being renters, if we can find a place we can afford," Rodrigues said.

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