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Foreclosures Drop in May

But rising unemployment and mortgage rates mean the decline is more an aberration than the start of a positive trend

The May foreclosure figures are just out, and the number of filings in the U.S. dropped 6%. That should have plenty of people rubbing their eyes in disbelief. Good news, really? Could this be the beginning of the turnaround that so many homeowners have been hoping for?

More like a mirage in the desert. While Irvine (Calif.)-based RealtyTrac reported the decrease, foreclosures remain at the third-highest level on record. Economists warn that foreclosure activity is likely to remain high for some time, and still get worse.

Property default notices, scheduled auctions, and bank repossessions were reported on 321,480 properties in May, down 6% from April but up 18% from May 2008. That means that 1 in every 398 homes received a foreclosure filing in May. Once again, Nevada, California, Florida, and Arizona topped the list of states with the highest foreclosure rates—even though foreclosure filings were down 4.5% in California and 9% in Florida from April.

Prime Borrowers Get Caught

Rising unemployment is becoming a major cause of foreclosures, which increasingly involve prime borrowers. Job losses have pushed Utah, Idaho, Oregon, Illinois, and South Carolina up the list of the highest foreclosure rates, says RealtyTrac Senior Vice-President Rick Sharga. (Utah, which was never a major subprime center, now has the fifth-worst foreclosure rate.) Another concern is that the expected reset of thousands of so-called pay-option adjustable-rate mortgages (ARMs), a particularly frightening loan that was popular in California, Nevada, and Florida during the boom, could cause another wave of defaults in coming years.

More than 1.7 million homes have already been repossessed since the foreclosure crisis began.

Brian Bethune, economist at IHS Global Insight (IHS) in Lexington, Mass., says the decline in foreclosure activity could be a good sign, but it's too soon to know. "This is only one month," Bethune says. "It can easily bump up in June."

March, April, and May had an unusually high number of filings because Fannie Mae (FNM) and Freddie Mac (FRE) in March lifted a moratorium imposed in November on foreclosure proceedings for all of its mortgages, Sharga says. State and local governments also have imposed foreclosure delays and moratoriums, which have only worked to delay the inevitable, he says.

"The delays basically push out the conclusion to this drama for months or years until everything processed," Sharga says. "While we've spared ourselves intense short-term pain, we've ensured that it will be longer than it otherwise would have been."

Sharga expects that foreclosures will peak this year. "We hit an unusually high peak in April," he says. "We will come down from those highs but settle at unusually high rates."

Gopal writes about real estate for BusinessWeek in New York.

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