Risky loans, broken dreams

Most of those loans were made to middle and low-income families desperate to buy homes in predominantly blue collar neighborhoods of west Santa Rosa, Rohnert Park and Petaluma.

For many, the American dream of owning a home has turned into a nightmare of sinking home values, forced sales, empty houses and ruined credit. A growing number of homeowners are locked into rising mortgage payments they can no longer afford and trapped in a home worth less than they paid.

Already, lenders have seized 630(cq) houses this year, up from 129 in all of 2006, guaranteeing that 2007 will be the bitterest year for homeowners since the county began keeping computer records in 1964.

Another 400 troubled properties are on the market, and lenders are threatening 300 homeowners a month with foreclosure if they can’t bring their loans current. Last year lenders averaged 93 foreclosure threats a month.

Nor is there any hope that the shakeout will soon be over. Next year interest rates will adjust upward for the first time on many of the 1,148 properties bought with risky loans in 2006. One-fourth of these homeowners could lose their homes, the U.S. Department of Housing and Urban Development said.

“We are going to have waves of foreclosures,” said economist Christopher Thornberg, who tracks the Sonoma County economy and predicted the current real estate crunch. “This thing has a long ways to go before it shakes out.”

The crisis has revealed the devastating legacy of subprime mortgages, a high-risk loan issued to buyers who did not qualify for conventional mortgages. Typically, these loans featured higher interest rates because borrowers did not have to document their income, make a down payment or worry about a blemished credit history.

The consequences have been especially severe for Latinos who bought into the promise that home ownership was within their grasp. Almost half who purchased homes in 2005 and 2006 relied on these financially dangerous mortgages.

In that critical two-year period, the rush of homebuyers who stretched to break into the housing market by taking out risky loans has set in motion a mortgage meltdown that has swept across the nation.

Rippling outward, hundreds of mortgage and real estate workers in Sonoma County are losing their jobs. Dozens of lenders nationwide are bankrupt, or laying off thousands of people, and those that remain have stopped lending except to the most creditworthy borrowers. Meanwhile, pensions, 401(k) plans, mutual funds and banks are losing billions of dollars, as the mortgages they hold lose value.

“What has made the subprime crisis so scary is the exposure of the entire financial system to these loans,” said Robert Eyler, chairman of the economics department at Sonoma State University in Rohnert Park.

To understand the forces that created the crisis, and the borrowers and neighborhoods that will be most affected, The Press Democrat analyzed three years of loans made in Sonoma County.

The analysis revealed the most prevalent use of high-risk loans — and likely the most damaging fallout — is concentrated in Santa Rosa’s Latino and lower-income neighborhoods. But many communities throughout the county, from Cloverdale to Petaluma, have large numbers of borrowers at all income levels who are stretched too thin.

Among the findings:

- Almost 20 percent of homes bought in 2005 and 2006 were funded with risky, high-rate loans, up sharply from 4 percent in 2004. In California, the rate was nearly 30 percent.

- In parts of west Santa Rosa, south Rohnert Park and east Petaluma, the rate was more than 40 percent.

- Latino home buyers were heavy users of the high-rate loans. In 2005 and 2006, more than 40 percent of Latino buyers relied on the risky loans, compared with 10 to 12 percent for non-Latino buyers. A decade ago, lenders were accused of denying loans to minorities, a practice called redlining. But as the housing market boomed and prices spiraled up, lenders were encouraged to make loans easier to get.

- Most high-rate borrowers in 2005 and 2006 said they had annual incomes between $100,000 and $200,000. However, many borrowers exaggerated their incomes to qualify for loans, sometimes at the direction of their brokers and lenders. During the housing boom, many lenders did not require borrowers to submit documents proving they earned enough to afford the monthly payments.

- Investors made 15 percent of the home purchases in Sonoma County in 2005 and 2006. They rarely used subprime loans; only 8 percent of the high-rate loans in the county were issued to investors who intended to become landlords.

- The average size of subprime second mortgages jumped almost 30 percent in two years, from $81,510 in 2004 to $103,881 in 2006. Most second-lien loans were the downpayment on a purchase made with a subprime first mortgage. Occasionally, homeowners used them to consolidate debt, take out cash or remodel.

- Subprime borrowers in Sonoma County extended themselves further than most Americans. In 2005, a Sonoma County loan was 3.4 times the income of the buyer, at the mid-point, or median. Nationwide, the median spread was 2.6.

- Most high-rate loans in 2005 and 2006 were used to buy mid- and lower-priced homes, but 14(cq) loans were for more than $1 million.

Almost $1.7 billion of debt issued to buy homes in Sonoma County is at risk, based on a Press Democrat analysis of 85,000 loans made in 2004 through 2006.

As alarming as the numbers are, Sonoma County had a smaller share of high-rate loans than the state. And the troubled properties represent a fraction of the homes in Sonoma County, where there are about 150,000 houses, 2,000 of which are typically for sale on any given day.

The turmoil in the housing market is rooted in the speculative fever that gripped Sonoma County in 2005 and 2006, where prices jumped 69 percent in three years and multiple offers were the norm. Many people, with good credit and bad, grabbed whatever loan terms they could get just to snag a house before prices and interest rates escalated beyond their reach.

Many took adjustable-rate loans, even though interest rates were rising.

Their plan was that home values would keep going up and they would refinance out of the high-rate loan in a couple of years.

They were helped by sales people who raked in six-figure incomes getting borrowers to accept high-rate loans, and by lenders who made a bundle selling the high-yield loans to Wall Street investors unaware of the risk. Interest rates on these loans have turned out to be 2 percent to 3 percent higher than a conventional loan.

“All this was based on the guess that housing prices would continue to rise,” Eyler said.

Some buyers dearly wanted to own their own home. Others simply wanted to get rich quick. Some didn’t understand the terms of their loan or the risk they were taking. Others just hoped they could get in and get out before the bubble burst.

Many are living happily in houses they could never have afforded otherwise. But some are losing their life savings and their shirts.

The tools for this trade were loans that started out with low teaser rates, permitted 100 percent financing, didn’t require income or job verification and allowed negative amortization that defers a portion of the payment by increasing the size of the loan.

These loans were called “subprime,” because they were often, but not always, made to subprime borrowers who couldn’t get a conventional loan because they had bad credit or no credit history, unverifiable income or an unusual property.

Now these loans are hitting borrowers with sharply rising rates, balloon payments and punishing prepayment penalties.

The true cost of these high-rate loans is coming due just as home values have fallen 10 percent since their peak in 2005. The drop in home prices has wiped out the refinance option for borrowers who can’t refinance for enough money to pay off the problem loan.

Thus, the same go-go financing that dangerously distended the housing bubble two years ago is now driving its deflation, and spooked lenders are slamming their doors on homeowners they embraced just months ago.

The unraveling of years of easy money, fueled by record low interest rates and promiscuous lending, has begun.

“A lot of people were gambling, playing the revolving refinance game. Now that the music has stopped playing, all sorts of people are standing with no chair. These people are in big, big trouble,” said economist Thornberg, who is the founding partner of Beacon Economics in San Rafael and Los Angeles.

The end of the subprime bonanza began in June 2004, when the Federal Reserve, after 3½ years of easy money, started slowly raising short-term interest rates. By June 2006, the Fed had raised a key short term rate 17 times, from 1.25 percent to 5.25 percent. That drove adjustable rates for mortgages up 2 percent or more.

Homebuyers stubbornly kept signing up for high-rate mortgages, trying to buy a house before rates and prices got completely out of reach. But eventually subprime borrowing started to fade. The number of new high-rate loans in Sonoma County fell 24 percent in 2006.

When analysts spotted rising default rates among subprime borrowers nationwide, the implosion of the subprime industry began. In July, credit rating agencies Moody’s and Standard & Poor’s said they were going to re-examine the ratings they’d been giving the subprime loan pools. Wall Street investors stopped buying the loans. Lenders stopped making them. Many subprime lenders have gone out of business.

The delinquency rate for subprime loans was 14.82 percent at June 30, the most recent available, the Mortgage Bankers Association reported. More than 5 percent were in foreclosure. By comparison, the delinquency rate for prime loans was 2.73 percent, and fewer than 1 percent were in foreclosure.

Investors in rental properties, in particular, are jumping ship. In California, 21 percent of investor loans were at least 90 days overdue or in foreclosure in June.

As the subprime market collapses, fingerpointing has begun. Borrowers are being accused of lying to lenders about their income. Mortgage brokers are being accused of lying to borrowers about the terms of the loan. Real estate agents are being accused of pressuring lenders to make the loan. Appraisers are being accused of inflating their estimates of home values. Lenders are being accused of predatory lending. State and federal legislators are threatening to crack down on them all. Lawsuits and prosecutions are likely. Wall Street investors want their money back.

In Sonoma County, real estate agents and mortgage brokers are fielding calls from borrowers fearful of losing their homes. While some lenders say they are trying to find ways to help their overextended borrowers, many homeowners cannot make their payments and will lose their homes.

“Some people got in over their heads, where they should have never been in the market, and with the softening of the market they have nowhere to go,” said Ross Liscum, a real estate broker for 28 years and co-owner of Prudential California Realty in Santa Rosa.

Library researcher Teresa Meikle contributed to this report.