The Star-Ledger

Subprime Time Bomb

Rising interest payments detonate foreclosure flood

The Star-Ledger — Sunday, July 1, 2007


It took William Gillette two years to save enough money to finally buy a home of his own. He had a steady job as a bus driver and solid credit, and now he had $26,000 for a down payment.

But after he found a two-family house he could afford in Newark, Gillette said, an aggressive loan officer persuaded him to finance the purchase with a subprime mortgage, a risky and complicated adjustable-rate loan.

After his mortgage payments nearly tripled, it took Gillette only four months to almost lose everything to foreclosure. At one point, his housing costs rose to $5,000 a month.

In the end, Gillette was able to refinance his home with a conventional, fixed-rate mortgage. Others haven't been so lucky.

ChartOver the past decade, subprime mortgages – high- cost, variable-rate loans for people whose income level or credit history make them ineligible for conventional, fixed-rate loans – have enabled millions of Americans to become homeowners for the first time.

But as the red-hot real estate market fizzled, the dream of homeownership has turned into a nightmare for thousands of overextended borrowers struggling with subprime debt, unable to keep up with rising interest payments or sell their homes.

The result has been a spike in mortgage delinquencies and foreclosures that will likely put more than 1 million Americans out of their homes nationwide, some experts predict, while bankrupting dozens of subprime lenders and blighting communities across the country.

Some states have suffered more than others. Because of New Jersey's overall affluence, subprime lending is far less common here than it is in other states such as Colorado, Florida and Ohio, which have seen a flood of mortgage delinquencies and foreclosures. Nationwide, 28 percent of borrowers in 2005 obtained subprime home loans, compared with 22 percent in the Garden State.

Within New Jersey, the collapse of the subprime mortgage market has hit some communities hard, while leaving others unscathed, according to a Star-Ledger analysis of federal lending data and interviews with homeowners, lenders, consumer advocates and real estate professionals. But in ways both dramatic and subtle, the effect is being felt around the state.

Blacks and Hispanics, already twice as likely as non-Hispanic whites to be denied a loan altogether, are three times more likely than whites to borrow under subprime terms when they are approved for a loan.

The towns with the highest percentages of subprime loans are all heavily minority: Irvington (66 percent), East Orange (61) and Newark (58) had the highest subprime lending rates.

Stung by rising delinquencies and the collapse of many subprime lenders, the mortgage industry has tightened the strings, making it harder for people with low income or poor credit to obtain a loan.

The worst may be yet to come. Billions of dollars of subprime mortgages originated at the peak of the housing boom two years ago are now resetting at higher rates, leading experts to predict a further spike in delinquencies and foreclosures this year and next.

The percentage of subprime loans in New Jersey that were delinquent at the end of 2006 climbed to 12.6 percent, from 8.6 percent at the start of the year, according to the Mortgage Bankers Association.

And foreclosures are approaching levels not seen since the recession of 1989 to 1991, said Jeffrey Otteau, president of Otteau Valuation Group, a real estate research firm in East Brunswick. New Jersey's foreclosure rate in the first quarter of this year was nearly 5 percent for subprime borrowers, compared with 2.7 percent at the end of 2005, the Mortgage Bankers Association reported.

"In other words, one in 20 subprime loans are being foreclosed on," Otteau said. "What's alarming here is we are approaching recession-like foreclosures without a recession."


Cardboard signs plastered on utility poles and trees reveal the struggles many homeowners are facing in the Greenwood section of East Orange.

"Cash 4 Homes," blares one sign in bright red letters. "We Buy Houses," reads another. "For Sale" signs and "For Rent" signs dot the landscape. "File For Bankruptcy - $450," yet another sign says.

This is ground zero for much of the most aggressive subprime lending in New Jersey.

"We're definitely seeing more foreclosures," said Glen Arnold, manager of East Orange's Department of Neighborhood Housing and Revitalization. "That increase is definitely disturbing and it will cause many of our neighborhoods to be in upheaval."

The Greenwood section, historically one of the city's most blighted neighborhoods, was the place Mayor Robert Bowser and the City Council targeted for redevelopment a few years back. The dream was to replace all the abandoned and dilapidated houses with new or rehabilitated Victorian- and Queen Anne-style homes, and there are indeed signs of rebirth.

But the spike in mortgage delinquencies as set the clock back. Many of the same homeowners who stretched themselves financially to buy a new home a couple of years ago are now either putting their homes back on the market or losing them to foreclosure.

"It undermines all the good we are doing," Arnold said.

Judith Brzuskiewicz, a loan counselor at New Jersey Citizen Action, a consumer watchdog, said the majority of bereft homeowners walking into her Newark office these days are black or Hispanic. Many of them are senior citizens.

"They are really stressed and they are ashamed, but they have done nothing wrong," she said. "They have been set up to fail."


During the real estate boom, rising home prices and voracious demand encouraged lenders to loosen their guidelines by offering loans to borrowers with even the shakiest credit. Wall Street banks cheered them on, extending generous credit terms to lenders and offering loan officers extra money to push subprime mortgages.

Wall Street's appetite for high-interest debt led to the proliferation of so-called option adjustable-rate mortgages, or option ARMs, which give borrowers several repayment options, including not repaying the principal. They are considered by housing and lending experts to be one of the most risky and complicated mortgage products ever created.

According to a report by industry analysts at Credit Suisse, about 80 percent of subprime loans made in 2006 included introductory "teaser" rates as low as 1 percent, which often lulled borrowers into a false sense of affordability - until, of course, their ultra-low payments started "resetting" at much higher rates.

What worries experts like Christopher Cagan of First American Real Estate Solutions, a California-based mortgage research firm, are all the adjustable-rate loans made in 2004 and 2005 during the height of the housing boom.

Cagan's forecast: 1.1 million mortgages – or 13 percent of all adjustable-rate mortgages originated between 2004 and 2006, with a total value of $326 billion – are heading for foreclosure in the next few years.


When the housing market was sizzling, anyone capable of fogging up a mirror when they held it under their nose could get a mortgage – or at least that's the running joke in lending circles.

And when homeowners found themselves in a bind? They simply refinanced or sold their home because sprices were forever heading skyward.

But now that prices have stalled in many places and lenders have tightened their standards to reduce their risk of loss, many of the exits have been blocked.

In the past few months, subprime specialists such as New Century Financial, Fremont Realty Capital, NovaStar Financial, Accredited Home Lenders and many others have exited the business, put themselves up for sale or declared bankruptcy.

Now, even some people with comfortable incomes and solid credit are having difficulty securing home loans on favorable terms.

Every week, Joel Reyes, a real estate agent at Foxtons who sells homes in East Orange and surrounding urban communities, says he runs into potential homebuyers who could have gotten a mortgage four to six months ago, but are now out in the cold.

"When you look at the subprime situation, a lot of lenders are not offering the same types of (mortgage products) they used to not too long ago, so homes are sitting on the market longer," Reyes said.

Reyes said up until recently, the average homebuyer he deals with was able to get 100 percent financing – no down payment – without income verification and with a FICO score as low as 580. Now, he said, lenders are looking for FICO scores – the standard measure of creditworthiness – of at least 650.

Otteau, who heads the East Brunswick real estate research firm, said that for those who already have subprime loans and are delinquent, it makes it more difficult for them to refinance their way out, thus increasing the likelihood of foreclosure.


Rafael Nieves, 46, managed to buy a home in Kearny by stretching beyond his means when the market was super-heated. Then, the trapdoor shut, and Nieves found himself in what he felt was a burning building with no way out.

"My loan officer told me, 'Don't worry about it. In a couple of months, you can refinance and get a lower rate,'" Nieves said. "But then reality hit."

He doesn't sugar-coat the truth: His credit was lousy due to a foreclosure in 1999, following a nasty divorce. And even though he earned a decent salary - about $60,000 – he knew buying a $350,000 home would be very difficult because his interest rate would be high.

Like many people in the subprime market, Nieves bought his house without a down payment, using an "80-20 mortgage," also known as a piggyback loan. That includes a primary mortgage that covers 80 percent of the home's cost, paired with a second loan for the remaining 20 percent. The homeowner puts nothing down.

The interest rate on the first mortgage was 8.1 percent. The rate on the second loan: 12.25 percent.

Nieves was told his payments could rise, but was assured by his loan officer at First Horizon in Kearny that he could refinance in as little as six months. (The First Horizon office in Kearny is no longer open.)

What the loan officer failed to mention, however, was that his payments – $2,100 on the first mortgage and $753 on the second mortgage – did not include taxes and insurance. Factoring in those costs, his monthly mortgage payments actually came to $3,600.

After Nieves and his wife, Delores, exhausted their savings, he contacted a loan counselor at Citizen Action. Because he had not missed a loan payment, Nieves was able to get out from under the 80-20 loan and into a more affordable fixed-rate loan.

"There was no way I could have kept this house," he said. "I would have lost it for sure."


Many of the most risky subprime products are being peddled by an army of unregulated loan officers – many who care more about their commissions than their customers, experts say.

In New Jersey, loan officers are not licensed by the state Department of Banking and Insurance. Anyone who can fill out a one-page form and pay an annual $100 fee is given the green light to sell mortgages – no background checks, no educational requirements, nothing. Since 2000, the number of loan officers has ballooned to 40,000, from 11,000.

Lenders typically offer loan officers fatter sales commissions on risky products like option ARMs to encourage brokers to push them, says Ehab Abousabe, a mortgage banker in Princeton Junction. "They want to make the money," he said.

Despite the risks, many borrowers place their trust in loan officers and sign their names on documents not fully understanding the implications.

William Gillette did. The Newark homeowner got an option-ARM with a low teaser rate of 1 percent that he thought would last for at least a year. But his payments quickly shot up.

Between his mortgage payment, his insurance and taxes and a costly heating bill, his out-of-pocket expenses came to a whopping $5,000. Gillette's monthly salary, at $3,000, didn't come close.

Thanks to his clean credit history, he was able to refinance with the help of counselors from Citizen Action. Today, his monthly mortgage payment is $2,254, including taxes and insurance.

"I could have gotten a fixed rate from the beginning because my credit wasn't bad," he said. "I was played."

Staff writer Robert Gebeloff contributed to this report.

Q & A — Some Help Available For Debtors

Q. I missed my mortgage payment. What should I do now?

A. If you are having problems making your mortgage payments, call or write your lender's Loss Mitigation Department.

More and more mortgage lenders are willing to work with borrowers to help ease the burden. Washington Mutual, for example, says it will refinance $2 billion in subprime loans, helping borrowers avoid foreclosure. The new loans will come with below-market interest rates.

When you contact your lender, explain your situation. Be prepared to provide financial information such as your monthly income and expenses. Without this information, they may not be able to help.

Meanwhile, stay in your home. You may not qualify for assistance if you abandon your property.

Q. What are my alternatives?

A. Your lender may be able to arrange a repayment plan based on your financial situation, and may even provide for a temporary reduction or suspension of your payments. You may qualify for this if you have recently experienced a reduction in income or an increase in living expenses.

You also may be able to refinance the debt and/or extend the term of your mortgage loan. This may help you catch up by reducing the monthly payments to a more affordable level. You may qualify for this if you have recovered from a financial problem and can afford the new payment amount.

Another option: Your lender may be able to work with you to obtain a one-time payment from the FHA Insurance fund to bring your mortgage current. You may qualify for this if your loan is at least four months delinquent but no more than 12 months delinquent and you are able to resume making full mortgage payments.

In some cases, a lender can file what's called a partial claim with the U.S. Department of Housing and Urban Development. If you qualify, HUD will pay your lender the amount necessary to bring your mortgage current. You must execute a promissory note, and a lien will be placed on your property until the promissory note is paid in full. The promissory note is interest-free and is due when you pay off the first mortgage or when you sell the property.

As a last resort, you may be able to "give back" your property to the lender. This won't save your house, but it is not as damaging to your credit rating as a foreclosure.

Q. How do I know if I qualify for any of these alternatives?

A. Your lender will determine if you qualify. A housing counseling agency can also help you determine which, if any, of these options may meet your needs and assist you in interacting with your lender.

Contact a housing counseling agency approved by the U.S. Department of Housing and Urban Development. Call (800) 569-4287 or TDD (800) 877-8339 for a counseling agency nearest you.

Here are some HUD-approved agencies in New Jersey:

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