Alt-A loans: Second wave of foreclosures ahead

A new wave of foreclosures is building in Sonoma County, one that echoes the subprime crisis that flooded the region’s housing market with distressed properties.

The tide of troubled loans, which first struck high-risk borrowers who did not qualify for conventional mortgages, is now spreading to people with good credit who purchased more expensive homes.

This time, it involves borrowers who took out mortgages known as Alt-A loans. Like the subprime loans that began imploding in 2006, these loans offered seductively low introductory payments that enabled many borrowers to buy or refinance homes that were pricier than they could otherwise afford.

Now, those borrowers increasingly are discovering the true cost of their loans. When the introductory period ends, monthly payments can jump 50 percent or more on the typical Alt-A loan, far higher than many borrowers can afford.

“They were sold to the consumer as affordable but the payments on the backside are large,” said Hans Bruhner, managing partner of First Priority Financial, a Forestville mortgage company. “It was a recipe for disaster that everyone should have seen coming.”

Today, there are 18,000 Alt-A mortgages in Sonoma County. They account for about 18 percent of the county’s 102,000 home mortgages — triple the U.S. average, according to First American CoreLogic, a real estate research company.

It is a far larger share of the county’s real estate holdings than subprime loans, which accounted for about 10 percent of local mortgages at their peak five years ago, according to First American CoreLogic.

Over the next three years, about two-thirds of the Alt-A borrowers in Sonoma County will see their payments jump sharply, according to First American CoreLogic. The trend will peak in the summer of 2011, the research firm projects.

The consequences could be damaging to both the borrowers and the county’s housing market.

Rising unemployment and falling home prices could thrust many Alt-A borrowers into foreclosure when their payments jump.

“The combination can be all it takes. I think that’s an important risk that Sonoma County faces,” said Steve Cochrane, regional economist for Moody’s Economy.com.

These problems are the latest sign that the mortgage crisis rippling across the country is far from settled. A record 12 percent of homeowners with a mortgage were behind on their payments in the first quarter, the Mortgage Bankers Association reported last week. Borrowers with good credit now make up the largest share of foreclosures nationwide.

The first wave came with the crash of subprime loans, sending foreclosures to record levels in Sonoma County. Nearly 7,200 borrowers stopped paying their mortgages in 2007 and 2008. Half of them have lost their homes.

Without intervention — from mortgage modifications, refinancing or an improving housing market — a larger wave of Alt-A loans could lead to another surge of foreclosures and prolong the housing slump.

“Nobody knew that house prices would be declining by this magnitude and be combined with a strong economic recession,” said Mark Fleming, chief economist for First American CoreLogic. “Some of these borrowers will find it too difficult to make their house payment.”

Many will be unable to refinance because their homes have dropped so sharply in value. Since home prices peaked at $619,000 in 2005, the median has tumbled 49 percent in Sonoma County. A quarter of the homes in the county are worth less than what the borrowers owe on their mortgages, according to First American CoreLogic.

Already, about one in five borrowers with Alt-A loans are two months or more behind on mortgage payments nationally. That is four times the historical delinquency rate for Alt-A loans, Fleming said.

The number of defaults could be even greater among Alt-A borrowers in Sonoma County and other high-cost regions of California, Fleming said.

“They are more at risk. We would expect given house price declines that the transition from delinquency into foreclosure is higher because of the inability to refinance or sell,” Fleming said. “Some maybe shouldn’t have taken these out, but they were commonly used as a way to gain affordability.”

Alt-A loans — short for alternative loans — is a mid-tier category of mortgages for borrowers with solid credit. It sits between the conventional loans available to people with top-notch credit and subprime loans, which were created for high-risk borrowers.

Most of these loans were made by a handful of lenders, including Countrywide Financial, Washington Mutual, World Savings and Downey Savings & Loan. Troubles with these and other mortgages weakened the lenders and sent shockwaves through the U.S. financial system. At the height of the financial meltdown, Countrywide was bought by Bank of America, Washington Mutual was taken over by Chase Bank and Downey was seized by federal regulators.

But during the heyday of the housing boom, Alt-A loans became a common tool to buy and refinance homes in Sonoma County.

Some borrowers turned to Alt-A loans to buy homes they otherwise couldn’t afford. Others used them to refinance their homes, fleeing rising payments on interest-only loans and other risky mortgages.

In a common scenario, buyers used subprime or interest-only loans featuring low, fixed payments that jump after two, three or five years. Then they refinanced into “pay-option” loans — the most popular Alt-A type — to keep payments low, said Mark Carrington, a First American CoreLogic analyst.

These loans allow borrowers to choose one of four payment options every month, including the option to make a minimum payment that doesn’t even cover the monthly interest costs.

“That type of loan quickly took over,” Carrington said. “Pay-option loans became really popular starting in 2004 and ramping up in 2005 and 2006. Home prices were still increasing weekly so people were looking for every possible excuse to afford these higher home prices at lower payments.”

Refinancing three years ago into a pay-option loan allowed Kristi and Marvin Laron to avert a jump in the monthly cost on the original loan the couple used to purchase their Cloverdale home. The loan’s minimum payment was $400 lower than their previous mortgage payment.

“Our whole goal was to pay less,” Kristi Laron said. “We figured we were going to refinance again. Who knew what was going to happen.”

Now the Larons are stuck with the loan and face a $1,000 hike in their monthly mortgage payment, boosting it to about $3,200. The couple can’t refinance because they owe more than the house is worth. Their lender has denied requests to change the loan and avert the payment jump, primarily because the couple has not fallen behind on payments and doesn’t have a financial hardship.

“We’re trying to avoid foreclosing on our house. We’re trying to do the right thing and nobody wants to help,” Kristi Laron said. “We both have jobs and we can’t really complain except for wondering what the future holds.”

Many borrowers, including the Larons, didn’t plan on staying in pay-option loans. They assumed their homes would be worth enough at the point when payments climbed that they could refinance or sell. The mortgages become risky if borrowers can’t afford higher payments or can’t refinance, placing them on a path toward foreclosure. Both scenarios are more likely as unemployment rises and home prices sink.

“If the economy stabilizes and those borrowers can successfully refinance their loans, they will be OK,” Cochrane said. “But there could be some difficulty. It depends how far underwater they are on their mortgage.”

Foreclosures began to soar two years ago and show little sign of receding. More homeowners with interest-only and subprime loans faced payment jumps at the same time home price declines took hold, making refinancing or selling difficult.

Borrowers with Alt-A loans increasingly face a similar fate. Economists do not forecast Sonoma County home prices to hit bottom possibly for another year, drawing more borrowers into the danger zone if they can’t get out of Alt-A loans.

A new wave of foreclosures could prolong the region’s housing slump by flooding the market with distressed homes and driving down prices.

“Households are having difficulty with their financial conditions and so we will see more additions to inventory because of foreclosures,” Cochrane said. “There is some risk that in places like Sonoma County there may be a higher share that can’t be helped.”

You can reach Staff Writer Michael Coit at 521-5470 or mike.coit@pressdemocrat.com.