Foreclosure Prevention: A Spike in Prime Mortgage Foreclosures

Just when we were getting used to the subprime crisis, lenders are now reporting record defaults and foreclosures related to prime mortgages. The trend indicates that the ongoing housing crisis isn't seeing any light at the end of the tunnel. Instead, we might be heading for another train wreck.

According to an August news report from CNN/Money, the delinquency rate for prime mortgages worth less than $417,000 (non-jumbo loans) recently hit 2.44 percent. That's more than a full percentage point higher than what was recorded last year, according to LoanPerformance, a company that tracks mortgage lending trends and statistics.

The pricier loans in the jumbo category racked up delinquency rates that are more than triple what they were just a year ago, and those overdue payment statistics may quadruple before the end of 2008. That means that the foreclosure crisis that was first relegated to the high-risk subprime market has now spread to the market populated by loans that represent the least amount of risk. Prime borrowers are the best of the bunch. They typically have to demonstrate above average credit, sufficient assets, and strong income before qualifying for their top-rated mortgages. In exchange for those stellar credentials, those who successfully acquire prime loans usually pay slightly lower interest rates and closing costs, and may be allowed to put down smaller down payments.

Prime customers not so prime

For investors who buy mortgages or banks that originate them, lower rates and down payments translate into less of a safety net.  Because homeowners now have less equity in their properties, it's likely that they'll owe more than the properties are worth. Millions of prime customers also used whatever home equity they had to borrow more, so even if the first mortgage is manageable, they may be having trouble paying the additional costs of second mortgages.

Especially disturbing is the fact that prime loans made last year are performing much worse than those originated in 2006. Things are going from bad to worse, in other words. We can expect three to four times as many prime mortgage defaults in 2008 compared to two years ago.

Loans harder to get

As the integrity of prime loans deteriorates, it creates a chain reaction of negative consequences. Lenders set aside more money in the form of "write-offs" to help offset the impact of future defaults. With a smaller pool of money to draw from, it becomes harder for consumers to get loans. The cost of loans then goes up in direct proportion to the increase in delinquencies, so fewer people are able to refinance out of their troublesome existing loans. This dynamic creates a self-fulfilling spiral of more foreclosures, lower home prices, crumbling equity, and increasing numbers of prime mortgage delinquencies.

These developments indicate that the crisis that most hoped would end this year may instead be gaining more momentum for a considerably longer, broader, more far-reaching crisis than anyone anticipated.