Susan, a legal secretary, is barely hanging on. A 35-year-old single mother of three, she is four months behind on her $640 mortgage payment. The reason: Her ex-husband landed in jail earlier this year for repeated driving offenses. That cut off child-support payments that amounted to almost half her income. Now that her husband is scheduled to be released, she is hoping her bank will give her a little more time to come up with back payments. "I just couldn't make it on my income," she says.
It's a hard-luck story. It's also the kind of headache that is sending shivers through the mortgage-lending business. The delinquency rate for home loans made in 1994 spiked to two-tenths of a percent in June, according to San Francisco-based researcher Mortgage Information Corp. That's up 60% from loans made the previous year--and it's almost as high as the delinquency rate during the depths of the last recession (chart). At the same time, consumer credit, now at record levels, shows signs of topping out as family budgets get overstrained. If the two forces play off one another, experts worry that delinquencies could continue to soar. Mortgage lenders "are setting themselves up for a real credit problem down the road," warns Mark M. Zandi, chief economist at Regional Financial Associates Inc.
The spike in weak loans is especially troubling because it is coming during a period of strong employment and economic growth. If troubled loans are soaring now, how high will they go in a weak economy? And rising delinquencies could help send the economy into a slide. If bankers tighten their lending standards, house hunters with iffy finances may be squeezed out of the market. That could hasten a slowdown in homebuilding. The sector already is braced for a 5% drop in 1996, brought on by a shrinking supply of creditworthy buyers who haven't already made their move.
What's behind the trouble in mortgages? In part, it's because the $1.9 trillion mortgage boom in 1992 and 1993 was dominated by established homeowners refinancing their mortgages at record low rates. By early 1994, less-secure new home buyers were flocking to popular adjustable-rate mortgages. When the initially low "teaser rates" of ARMs were ratcheted up to market rates, many new homeowners felt the mortgage equivalent of sticker shock.
Now, the higher monthly payments are beginning to spell big trouble for some borrowers. Total consumer installment debt is now nearly $1 trillion. That's equal to 21.42% of total disposable income, an all-time high, and up from 20.4% last year. And growth in total installment debt slowed in September, indicating that consumers may be maxing out. "A lot of clients just have bad money-management skills," says Vaughn D. Irons, a manager at Consumer Credit Counseling Service of Greater Atlanta.
SALE. Lenders also must shoulder some of the blame. When home lending fell to just $769 billion last year from 1993's record $1 trillion, the industry relaxed its mortgage-loan criteria to attract business. The result: 46% of the private-sector mortgage loans made in 1994 were secured with less than a 20% downpayment--the largest share of such mortgages since 1984. And more than half of those loans were made with less than 10% down--again the largest percentage in a decade. Some bankers kept easing home-loan standards into early 1995, according to a new survey by national bank regulators.
In some cases, lenders approved mortgages without requiring a formal appraisal of the home. And borrowers with checkered credit histories found it easier to win approval. Ilene Fischer, a mortgage broker in North Hollywood, Calif., says she had customers with past loan-collection problems who qualified for mortgages after showing a clean credit report for just one year--vs. two years in the past. And the iffy borrowers often were only required to make downpayments of 5%. "We've seen some loans go through that we've been pretty amazed at," says Fischer.
Another factor behind the shrinking size of downpayments: laws requiring banks and the Federal National Mortgage Assn. and Federal Home Loan Mortgage Corp., the federally chartered mortgage giants that purchase and secure mortgage loans, to help more low- and moderate-income borrowers who want to buy homes.
Meanwhile, home values in most parts of the country have been rising slowly, if at all. So homeowners looking to move up to a larger house often don't have much equity to put toward a downpayment. With shrinking borrowers' equity, late payments have been rising steadily.
Experts contend that underwriting standards are actually higher now than in the mid-1980s, when delinquency rates where running about 30% higher. But "the key question is how will this higher-risk business perform if the market is stressed?" says Sanford C. Bernstein & Co. analyst Jonathan E. Gray. "No one really knows."
To be sure, mortgage lenders are stepping up defensive measures against doubtful mortgages. Earlier this year, Fannie Mae increased the amount of mortgage insurance--which covers its costs of foreclosing on a home and selling it--required for home buyers putting less than 10% down.
TECH FIX? Some industry veterans insist the move toward low downpayments can be accomplished without a major increase in defaults. They point to an industry shift toward automated underwriting, which speeds up loan-processing time. Fannie Mae and Freddie Mac both have introduced computer-underwriting systems this year that can process and approve some applications in 48 hours. Such systems eventually will allow mortgage lenders to better price their loans, reducing charges for buyers with good credit while potentially increasing those to high-risk borrowers. "The mortgage industry has not been cutting-edge in technology," concedes Freddie Mac Executive Vice-President Michael K. Stamper. "It is now catching up fast."
But some consumer groups worry that the new systems will cut some low-income and minority borrowers out of the market. Concerned about credit quality, both Fannie and Freddie now use a technique called credit scoring. A staple in the consumer-lending business, scoring uses an applicant's credit history to predict the likelihood of repayment. Fannie and Freddie insist the change won't result in discrimination. But others worry that low-income buyers will have a hard time getting mortgages approved. "There may be no incentive for lenders to work with those [borrowers] on the margin," frets Allen Fishbein, general counsel for the nonprofit Center for Community Change in Washington.
For now, though, the bigger worry is that the mortgage industry hasn't done enough to shore up the quality of its loans. Dan Feshbach, president of Mortgage Information, sees little evidence that delinquencies are under control yet. That means that more people such as Susan in Atlanta will experience both the joy--and sometime agony--of homeownership.
Why Bad Mortgages Are On The Rise
Despite a strong economy, the percentage of mortgages from last year that are at least 90 days late is almost as high as during the 1991 recession.
LOWER DOWNPAYMENTS Thanks to low-income-lending initiatives and modest home-price appreciation, about one-quarter of home buyers now put less than 10% down. That makes monthly payments higher and higher to maintain.
CONSUMER DEBT The burden of consumer debt has reached an all-time high. That makes it difficult for some homeowners to keep current on their mortgage payments.
AGGRESSIVE UNDERWRITING Mortgage originations fell nearly 25% early last year in the wake of the 1993 refinancing boom. So some mortgage underwriters loosened underwriting standards to drum up business.
ADJUSTABLE-RATE MORTGAGES As the interest rate on popular ARMs has ratcheted up, many homeowners are finding the increased monthly tab a tough one to cover.