BANKRUPTCY UPDATES

Foreclosures Spreading from Subprime Borrowers to Prime Borrowers

There's no question that the foreclosure crisis has been forcing the hands of not only the news media but also politicians.

With the rate of foreclosures steadily increasing and median home prices dropping like lead, economists and policymakers alike have been scratching their heads about what to do fix the situation.

But new reports suggest that they're not hitting on any answers, as the foreclosure crisis seems to be getting worse.

As new articles in the Los Angeles Times, Minneapolis Star-Tribune and New York Times report, loan defaults and subsequent foreclosures have been rising among prime borrowers, that is, borrowers who have exemplary credit histories.

That's a sobering fact, because the focus of the current housing woes has been the subprime mortgage market. Subprime borrowers, as many people have come to know over the past year, are borrowers with bad or limited credit histories.

Before recently, subprime borrowers had little to no access to mortgage loans because they were considered too risky.

However, certain "innovations" in the mortgage lending sector, such as no-down-payment loans and adjustable-rate mortgages, qualified more and more buyers for large loans like mortgage loans.

Some economists, such as one quoted in the New York Times article, believe that the subprime factor was merely a symptom of a greater underlying problem: what he refers to as an "asset bubble" or "credit bubble."

He explains that the great many borrowers trying to exploit the dramatically rising home values caused the artificially-inflated home prices to rise even higher. This phenomenon wasn't limited to subprime borrowers, and the consequences aren't limited to them, either, which is what we're seeing now.

One of the major difficulties facing borrowers of any kind is the adjustable-rate mortgage (ARM), whose fluctuating rates cause mortgage payments to fluctuate equally. When rates were at an historic low in the early part of this century, causing many people to buy homes, the only place for rates to go was up, and house payments with them.

Of course, this phenomenon of dramatically rising mortgage payments would cause financial strain on many borrowers regardless of their credit history. It forced many of them to consider bankruptcy.

The payment-option ARM is even more complicated, leading the AARP to dub it a "time bomb" for everyone but financial whizzes.

These "option ARMs" allow borrowers the option of paying one of four payments each month to encourage borrowers to pay off loans early.

Of course, with such added benefit comes added risk, and the intricacies of the option ARM-interest rate adjustments, "pay up" dates, etc.-require a level of financial sophistication that most homeowners simply don't have.

During the housing boom, many prime borrowers were sucked into the ARM or option ARM trap when they decided to refinance their homes at the lower interest rates. Now many prime borrowers find themselves in the same boat as subprime borrowers.

Statistics released by the Mortgage Bankers Association show that, as of September of 2007, around 4% of prime loans were in foreclosure. While it remains much lower than subprime loans in foreclosure, that number is the highest rate recorded for prime loans since they were recorded separately from subprime loan statistics.

Prime borrowers have long been the backbone of the mortgage market, allowing mortgage lenders to take more risks on subprime borrowers. However, with more and more defaulting prime borrowers, the market stability may find even more trouble as their support system slowly crumbles.

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