By Dan Levy and Bob Ivry
Sept. 12 (Bloomberg) -- For Dean Nessen, the choice of a mortgage was easy. By agreeing to pay only interest for three years, the self-employed salesman didn't have to show proof of income and landed a rate of 6.25 percent.
Now, four years later, Nessen's industrial coatings business has gone belly up and his rate has jumped to 10.6 percent. He can't afford the payments and may have to move his family out of their home in Commerce Township, Michigan.
Homeowners lured by low introductory rates to Alt-A mortgages, which typically require little or no proof of a borrower's income, may fuel the next wave of foreclosures and further delay a recovery from the worst housing decline since the 1930s. Almost 16 percent of securitized Alt-A loans issued since January 2006 are at least 60 days late, data compiled by Bloomberg show. Defaults will accelerate next year and continue through 2011 as these loans hit their three- and five-year reset periods, according toRealtyTrac Inc., an Irvine, California-based foreclosure data provider.
``Alt-A will be another headache,'' said T.J. Lim, the London-based global co-head of markets at Unicredit Group. ``I would be very worried about anything issued in the last half of 2006 and the first half of 2007.''
About 3 million U.S. borrowers have Alt-A mortgages totaling $1 trillion, compared with $855 billion of subprime loans outstanding, according to Inside Mortgage Finance, a trade publication in Bethesda, Maryland. Of the Alt-A borrowers, 70 percent may have exaggerated their income, saidDavid Olson, president of mortgage research firm Wholesale Access in Columbia, Maryland.
Fannie, Freddie Exposure
Risks extend beyond banks and consumers to Washington-based Fannie Mae, which owned or guaranteed $340 billion of Alt-A mortgages in the second quarter, equal to about 11 percent of its total single-family mortgage credit book of business. The loans accounted for half of the company's second-quarter credit losses, according to a regulatory filing. Alt-A holdings at McLean, Virginia-based Freddie Mac were $190 billion, or 10 percent of its mortgages, in the second quarter, according to the company's Web site.
Fannie Mae said on Aug. 8 it won't accept any new Alt-A loans after Dec. 31.
While subprime home loans describe a type of borrower --those with bad or limited credit histories -- Alt-A, or Alternative A- paper, are shorthand for a type of loan developed in the mid- 1980s.
`No Doc' Push
Many Alt-A loans go to borrowers with credit scores higher than subprime and lower than prime, and carried lower interest rates than subprime mortgages.
So-called no-doc or stated-income loans, for which borrowers didn't have to furnish pay stubs or tax returns to document their earnings, were offered by lenders such as Greenpoint Mortgage and Citigroup Inc. to small business owners who might have found it difficult to verify their salaries.
Alt-A loans were used to expand home ownership among first- time buyers as prices climbed out of reach for many of them, according to Rick Sharga, executive vice president for marketing at RealtyTrac.
``To grow, the market had to embrace more borrowers, and the obvious way to do that was to move down the credit scale,'' said Guy Cecala, publisher of Inside Mortgage Finance. ``Once the door was opened, it was abused.''
By 2005, the credit score required for an Alt-A loan fell as low as 620, traditionally the definition of a subprime borrower, said Steve Donlin, a former mortgage broker who's now vice president of operations at Loan Safe Solutions Inc. in Corona, California, which helps people negotiate changes to loans they can't afford.
Almost all stated-income loans exaggerated the borrower's actual income by 5 percent or more, and more than half increased the amount by more than 50 percent, according to a study cited by Mortgage Asset Research Institute in its 2006 report to the Washington-based Mortgage Bankers Association.
Some mortgage brokers and loan officers urged borrowers to inflate incomes, exaggerate job titles or increase loan size because lenders could profit by selling riskier Alt-A loans to investors, said Jim Croft, founder of Reston, Virginia-based Mortgage Asset Research Institute.
``When homes prices were going up, people were saying, `If I don't buy now, I'll never be able to buy,''' Croft said.
Fraud for Housing
Falsifying information on a mortgage application is a crime, said FBI Special Agent Stephen Kodak in Washington. It's rarely investigated because the FBI targets what it calls ``fraud for profit'' schemes involving people who lie to get multiple mortgages and have no intention of repaying them, rather than individuals lying about their income to buy a house they intend to live in, Kodak said.
The Alt-A market grew more than seven-fold to $400 billion in 2006 from $55 billion in 2001, according to Inside Mortgage Finance.
Since home prices peaked in July 2006, they have fallen 18.8 percent nationally, leaving an estimated 29 percent of borrowers who bought in the last five years with houses worth less than what they owe on their mortgages, according to Zillow.com, an Internet real estate valuation site.
The ``serious delinquency'' rate for Alt-A mortgages issued in 2007 hit 10 percent in half the time it took for those from 2006 to reach the same level, Moody's Investors Service said in a report last month.
``Alt-A loans have turned toxic,'' Cecala said. The combination of exaggerated income, falling home prices and payments that reset higher is ``a recipe for disaster,'' he said.
When Linda and Mark Pavlick bought their three-bedroom house in West Deer, Pennsylvania, 16 years ago, they paid $68,000. They now owe $105,000. The house was recently appraised for $80,000, Linda Pavlick said.
``The decision to redo the loan was probably the worst decision we ever made,'' said Pavlick, an administrative assistant at a psychiatric hospital.
When their interest rate jumped to 12.25 percent last year, making the monthly payment about half their combined take-home pay, the Pavlicks and their 17-year-old son had to choose between paying the mortgage and the monthly gas bill, Linda Pavlick said.
Mortgage or Heat
``We went three months without gas,'' she said. ``I used an electric plate to cook. But heating up the water for a shower, to wash your hair, that was the toughest. I've learned a lot of lessons, but this isn't one I'd wish on anybody.''
The Pavlicks turned to a community housing group called Association of Community Organizations for Reform Now, or ACORN, which helps borrowers recast their loans with lenders. Still, Linda Pavlick said she and her husband, who operates road-patching equipment for the Pennsylvania Department of Transportation, have no idea if their lender will comply.
``There's been rough times in all of this and I don't know where this is going,'' Pavlick said.
About one-third of Alt-A loans are payment-option adjustable- rate mortgages, said Donlin of Loan Safe Solutions.
A borrower with an option ARM can pay as low as 1 percent interest by deferring some of the money owned until the loan balance reaches a predetermined limit, usually 110 percent to 120 percent of the original mortgage amount. Then payments immediately rise. They also automatically shoot up after a set time period of up to five years.
The loans accounted for 8.9 percent of the almost $3 trillion in U.S. home loans made in 2006, according to an estimate by Inside Mortgage Finance.
Wachovia Corp., with $122 billion, and Washington Mutual Inc., with $52.9 billion, were the U.S. lenders with the most option ARMs on their balance sheets at the end of the second quarter, according to regulatory filings. Both ousted their chief executive officers, Wachovia in July and Washington Mutual on Sept. 8, over failure to stem mortgage losses.
The value of non-performing real estate loans at Wachovia, the fourth-largest U.S. bank, rose to $11.9 billion, or 2.4 percent, of all loans on the books in the second quarter and increased from the $1.9 billion, or 0.5 percent, of non-performing loans a year earlier.
Non-paying consumer real estate loans at Charlotte, North Carolina-based Wachovia increased five-fold, to $7.6 billion, in the second quarter from $1.5 billion a year earlier. The bank said those losses were driven by ``Pick-a-Pay'' loans, otherwise known as payment-option adjustable-rate mortgages.
``We continue to mitigate the risk and volatility of our balance sheet through prudent risk-management practices, including increased collection efforts,'' Wachovia said in its quarterly report, issued Aug. 11.
Washington Mutual, the biggest U.S. savings and loan, said the value of option ARMs that weren't being paid grew to $3.2 billion in the second quarter from $1.6 billion at the end of 2007, according to regulatory filings. The Seattle-based thrift announced it would no longer offer option ARMs.
Other banks with option ARM holdings include Countrywide Financial Corp., acquired July 1 by Charlotte-based Bank of America Corp., with $27 billion; Newport Beach, California-based Downey Financial Corp., with $6.9 billion; and IndyMac Bancorp Inc., the Pasadena, California-based lender now run by the Federal Deposit Insurance Corp. after a run on deposits, with $3.5 billion, according to Inside Mortgage Finance.
Lehman Brothers Holdings Inc., the New York-based securities firm that yesterday entered talks with potential buyers, held $26.6 billion of securities backed by Alt-A loans in 2007, ranking second behind Countrywide, Inside Mortgage Finance said. Washington Mutual, under pressure to raise capital for the second time in five months to cover loan losses, ranked ninth with $9.65 billion.
The backlog of growing mortgage delinquencies has overwhelmed mortgage servicers, who collect monthly payments from homeowners and distribute them to securities investors, said Nessen, the Michigan borrower.
Nessen, 41, said he made phone calls repeatedly over five months and failed to reach a person who could work out a deal with him at Saxon Mortgage Services Inc., the service company that collects his payments. Saxon was purchased by Morgan Stanley in 2006.
``Granted, they are overwhelmed by people in my situation,'' Nessen said. ``But that doesn't help me.''
Saxon has responded to higher delinquency rates by increasing the number of employees working on loan modifications by 60 percent during the past three months, according to company spokeswoman Jennifer Sala.
``Saxon is committed to structuring solutions in a timely manner for qualified borrowers so they can remain in their homes,'' Sala said in an e-mail.
Bank of America, which became the largest U.S. mortgage servicer when it acquired Countrywide, has 4,500 counselors to help borrowers modify loans, more than double the number the two lenders had last year, according to spokesman Terry Francisco.
Des Moines, Iowa-based Wells Fargo Home Mortgage, the second- largest U.S. mortgage servicer, increased the number of employees handling loan modifications to 1,000 from 200 in 2005, said spokesman Kevin Waetke.
Chase Home Lending, a unit of New York-based JPMorgan Chase & Co., expects to spend at least $200 million more in 2008 on servicing loans, loss mitigation and defaults than it did last year, said spokesman Thomas Kelly.
Nessen said the home he shares with his wife and three children, ages 7, 3 and 13 months, is scheduled for sheriff's auction at the end of the month.