Academic journal article Economic Review (Kansas City, MO)

Rising Foreclosures in the United States: A Perfect Storm

Academic journal article Economic Review (Kansas City, MO)

Rising Foreclosures in the United States: A Perfect Storm

Article excerpt

Residential foreclosures in the United States have been rising very rapidly since 2006. In the second quarter of 2007, the share of outstanding mortgages in some stage of foreclosure stood at 1.4 percent, near historic highs and up from less than 1 percent a year earlier. The number of mortgages entering the foreclosure process reached an all-time high in mid- 2007, suggesting that the foreclosure surge is likely to get worse before it gets better.

The foreclosure surge was created by a perfect storm of events. First, in recent years the share of subprime mortgage originations increased substantially. Second, foreclosure rates for adjustable-rate mortgages (ARMs) have increased considerably, especially for subprime ARMs. This increase is largely due to rising short-term interest rates and to payment resets for many nontraditional mortgages. Finally, high loan-to-value originations in recent years, coupled with stagnant or falling home prices, have left many people with insufficient equity to sell or refinance their homes.

Edmiston and Zalneraitis provide a detailed dissection of the current foreclosure surge. They conclude with a discussion of why the foreclosure situation is likely to get worse over the next two to three years and why it is likely to improve afterward.

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Residential foreclosures in the United States have been rising very rapidly since 2006. In the second quarter of 2007, the share of outstanding mortgages in some stage of foreclosure stood at 1.4 percent, near historic highs and up from less than 1 percent a year earlier. The number of mortgages entering the foreclosure process reached an all-time high in mid-2007, suggesting that the foreclosure surge is likely to get worse before it gets better.

The foreclosure surge was created by a perfect storm of events. First, in recent years the share of subprime mortgage originations increased substantially. Subprime mortgages--that is, home loans made to borrowers with impaired credit (see glossary)--have substantially higher rates of foreclosures than prime mortgages. Second, foreclosure rates for adjustable-rate mortgages (ARMs) have increased considerably, especially for subprime ARMs. This increase is largely due to rising short-term interest rates and to payment resets for many nontraditional mortgages. Finally, high loan-to-value originations in recent years, coupled with stagnant or falling home prices, have left many people with insufficient equity to sell or refinance their homes.

This article provides a detailed dissection of the current foreclosure surge. The first section highlights the current trends in foreclosure rates, both over time and across space. The second section describes the foreclosure process and the circumstances that typically lead lenders to foreclose. The third section details the three factors underlying the current spike and explains how these factors have interacted to create a perfect storm. The article concludes by discussing why the foreclosure situation is likely to get worse over the next two to three years and why it is likely to improve after that time period.

I. HISTORICAL AND GEOGRAPHIC PERSPECTIVE

As economic conditions change, the foreclosure rate typically changes as well. Since 1979, however, foreclosure rates have rarely declined for an extended period of time (Chart 1). Foreclosure rates rose steadily until the mid-1980s. While there are many explanations for this upward trend in the 1980s, the likely causes were high interest rates, weak real estate markets, and an energy glut in some parts of the country. Foreclosure rates then leveled off until about 1995, when they began to rise again. Foreclosures spiked to a record high in 2002, largely as a result of the recession in 2001. After this spike, rates declined substantially and were settling to levels similar to those in the mid-1990s when the current surge began in early 2006. …

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