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The credit crisis.

Mortgage foreclosures and personal bankruptcy filings have been steadily increasing, in part as a result of the use of home-equity borrowing for purposes other than home improvement, such as debt consolidation. Potentially troubling are the "125 LTV loans," junior mortgages in which the borrower is allowed an aggregate mortgage debt totaling as much as 125 percent of the market value of the mortgaged property. Although this junior debt can clearly benefit both the borrower and the lender, an increased reliance on credit should be recognized as a borrower behavior pattern that threatens to push up the rates of default and bankruptcy among a rapidly growing universe of overextended debtors.

Borrowers for whom mortgages were originated in 1994 and 1995 not only exhibit a greater use of credit, but also have higher delinquency rates on their unsecured credit accounts, according to Gordon Monsen in a June 1996 article in Mortgage Banking. Monsen predicted that servicers could expect higher loss levels from higher loan-to-value lending in the subprime market, a trend accelerated by aggressive home-equity lending programs of recent years.

What are the factors contributing to this trend, and how should key indicators be interpreted?

A February 1997 report by Merrill Lynch & Co. predicted that origination of second mortgages for debt consolidation will exceed $200 billion in 1997, up from $150 billion in 1995. The report also predicted that securitization of these loans could reach $50 billion to $75 billion annually through 2001, up from $33-5 billion in 1996. In fact, the volume of securities backed by home-equity loans in the first half of 1997 increased more than 30 percent from the first half of 1996, to $27.1 billion, while the volume of securities backed by credit card loans declined 47 percent, to $14.6 billion.

Although such junior mortgages may be seen as a desperate measure for cash-strapped homeowners, they can provide benefits to both the borrower and the lender. The borrower typically refinances unsecured debt at significantly lower interest rates - 10 to 16 percent for home-equity loans vs. 18 to 21 percent for credit card debt. Also, the interest payments for the portion of the second mortgage that does not exceed the property value may be tax deductible. The lending institution benefits through generation of loan origination and servicing fees.

Without an accompanying change in consumer behavior to stem future reliance on credit cards, the danger of second mortgages taken as debt consolidation loans becomes apparent. Recent trends indicate that no such behavioral change has occurred. Despite more debt consolidation loans being originated, unsecured consumer debt continues to grow, indicating that credit card use has continued to increase. Bank credit card accounts upon which a payment was 30 days or more overdue were 3.5 percent of all such accounts with outstanding balances at the end of the third quarter of 1996, according to the American Bankers Association. This represents an increase of 40 percent from the 1994 rate for the same period. Total credit card debt increased 12 percent from June 1996 to June 1997, to $394 billion, while unused lines of credit grew 22 percent to $1.5 trillion.

In addition, the Mortgage Bankers Association reported that "the seasonally adjusted delinquency rate for mortgage loans on one-to-four residential properties was 4.26 percent in the third quarter of 1997, up 2 basis points from the second quarter."

Foreclosures also are increasing. The percentage of loans in foreclosure increased to 1.09 percent as of the end of the third quarter of 1997, up from 1.08 percent as of the end of the second quarter of 1997, according to the Mortgage Bankers Association.

Finally, personal bankruptcy filings are becoming routine. A record 1.3 million people made personal bankruptcy filings in 1997, up 19.5 percent from 1996. Some $30 billion in consumer debt was discharged by bankruptcy courts in 1996. This trend is particularly disturbing when projected through the end of the decade - if it continues, more than 10 percent of the 100 million households in America will have filed for bankruptcy during the 1990s.

All of these statistics indicate that Americans are increasingly not able to meet their credit obligations, and many do not appear overly threatened by the consequences. As a result, one might think that credit would have tightened over the corresponding period. In fact, credit has become increasingly available.

The market for high loan-to-value (HLTV) and negative-equity mortgages has exploded during the last two years. Moody's Investors Services in April of last year predicted that HLTV loan originations would reach $8 billion in 1997, up from $3.5 billion in 1996 and $200 million in 1995. Credit has never been more convenient to obtain - many American households seem to be flooded with "preapproved" credit card applications in the mail.

Also during 1997, a national home-improvement supply chain and a financial services company teamed to make second mortgages available in-store. Now, while shopping for paint, wallpaper and lighting fixtures, homeowners can also apply for second mortgages during a store visit. An industry analyst compared the move to the established practice of financing arrangements made by used-car dealers.

But that's not all. A new type of credit card was introduced last November, enabling borrowers with blemished credit histories to secure debt with the equity in their homes. An industry consultant heralded the combination of subprime mortgage lending and secured credit cards as a "marriage made in heaven." Some marriage.

Our experience in deficiency recovery at Quantum Capital indicates an identifiable behavioral pattern leading to mortgage default. First, a cash-strapped homeowner takes a second mortgage to pay down credit card or other unsecured debt. It is at this time that the borrower is most in jeopardy, from a financial point of view.

Although most borrowers have every intention of repaying loans, all that is necessary to put the mortgage at risk is the loss of a job, a divorce, a serious illness or some other catastrophe. At these times borrowers live off their savings while continuing to make payments on mortgages and other debts. As savings are depleted, credit cards are used increasingly for routine purchases, such as groceries. Meanwhile, mortgage payments continue. Finally, immediately before default of the mortgage, the borrower draws down the balance of his or her remaining credit lines. Mortgage default could follow this event by 30 to 60 days.

Much attention was paid last year to the National Bankruptcy Review Commission's recommendations that Congress consider changing the bankruptcy code to make debt collection more difficult and to curtail alleged predatory and unfair lending practices.

Some of the commission's recommended changes seem to ignore consumer behavior while treating credit as a consumer entitlement.

But credit has always been a consumer privilege, not an entitlement. The growth in the subprime mortgage market during the middle of this decade has been good for the nation's economy, but it is not an excuse for lenders to take their collective eye off consumer behavior relative to credit.

Statistics show the typical American has become comfortable living well beyond his or her means and that subprime second mortgages, intended to provide a fresh start, may be contributing to continuation of the behavior that created the problem in the first place. We hope the typical American home has not become a house of cards - credit cards. If indeed it has, now is the time to cut those cards in half, before the house collapses.

Paul Gardner is president of Quantum Capital, Inc., Austin, Texas, a asset-based debt resolution specialist operating in both the consumer lending and commercial markets. The company's clients include financial institutions and governments agencies that have decided to resolve debt deficiencies, recover on deficiency judgments and recover on charge-off portfolios.
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Title Annotation:increase in mortgage foreclosures and personal bankruptcy filings
Author:Hewitt, Janet Reilley
Publication:Mortgage Banking
Date:Feb 1, 1998
Previous Article:Investigating captive mortgage reinsurance.
Next Article:Keeping things simple.

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