The Evolution of Mortgage Defaults

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The Evolution of Mortgage Defaults

After the housing bubble peaked in 2006, sales of new and existing homes plummeted, construction nearly ceased, and prices dropped an average of 30 to 35 percent, with prices of new homes dropping more than 50 percent in some places.  Foreclosures and empty developments were everywhere.  Then, after bottoming in the spring of 2009, sales, construction activity, and prices all headed up.  Nevertheless, the volume of mortgage defaults has continued to rise.  According to, the number of homeowners losing their homes to foreclosures across the country rose to a new peak in March 2010, with more than 1 in every 1,000 homes being foreclosed.1  At that time, foreclosure resales accounted for 22.2 percent of all U.S. home sales. 

Foreclosures fall into three major categories. 

The first type is the traditional foreclosure.  This occurs when something happens that leaves the homeowner without enough money to make his monthly payment for several months in a row.  For instance, the homeowner loses a job or incurs extraordinary expenses that absorb the money that would have been used to pay the mortgage. 

In the Great Recession, like every downturn since mortgage debt became commonplace in the 1920s, such traditional foreclosures are common. 

The second and largest category in recent times is the reset-driven default.  These defaults happen to people who are barely able to afford the payments under the introductory or "teaser terms."   Because little verification of income or assets was involved in so many adjustable rate mortgages at the height of the boom, it was very common for borrowers to get in over their heads. 

Today we're just past the half-way point in the reset process for mortgages written between 2003 and 2007.  So there is a good chance that this category of default will continue to rise. 

However, the most immediate problem lies in the third type of default:  strategic defaults inspired by "underwater mortgages."  As of the end of the first quarter, the percentage of American single-family homes with mortgages in negative equity rose to 23.3 percent, up from 21.4 percent in the previous quarter, according to the Zillow Real Estate Market Reports.2 

Fortunately, this problem is concentrated primarily in a few states.  According to First American Corelogic, 70 percent of all mortgaged properties in Nevada were underwater at year-end 2009.  This compares to Arizona at 51 percent, Florida at 48 percent, Michigan at 39 percent, and California at 35 percent...

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