Foreclosure rates could soar

Moody's Economy.com forecasts that defaults won't peak until 2008 due to ARM resets and falling home prices.

By Les Christie, CNNMoney.com staff writer
July 26 2007: 1:52 PM EDT

NEW YORK (CNNMoney.com) -- The already poor performance of many mortgage loans will worsen substantially through the rest of the year, according to an analysis released Thursday by Moody's Economy.com.

The company predicts that 2.5 million first mortgages will default this year, with little chance for improvement soon - Economy.com expects delinquencies to peak in the summer of 2008 at 3.6 percent of all outstanding mortgage debt, up from 2.9 percent during the first three months of 2007.

The worst-hit loan category will be subprime adjustable-rate mortgages (ARMs). Economy.com expects foreclosures for those loans to hit 10 percent of that group by mid-2008. The foreclosure rate for that group is currently 4 percent and was as low as 2.5 percent in 2005.

"The economic fallout from the devolving mortgage market will be substantial, but conditions would be even worse if not for a continued generally sturdy job market," said Mark Zandi, chief economist of Moody's Economy.com.

Subprime ARMs issued during the last three months of 2006 could fare worst of all, with a projected foreclosure rate of just under 20 percent during the fall of 2011. That would mean a full one in five owners with subprime ARMs would lose their homes. (Foreclosures: Most ruthless states)

One-time, high-flying markets will suffer the most. California's Central Valley is particularly vulnerable, according to the study. Other hard-pressed areas cluster in Florida, Nevada, New York, Arizona and the District of Columbia.

The delinquency increase will be sparked by two main factors: Falling home prices and rising interest rates on adjustable mortgages. Another drop in new home sales.

"As [interest] rates reset, it will make it more difficult for borrowers," said Zandi. They'll face higher monthly mortgage payments even as other housing expenses - taxes, energy, insurance - are also growing.

Falling home prices - Zandi forecasts a 7 percent drop nationwide for the year -mean that less home equity is available for homeowners to tap to pay bills.

The impact of housing woes will be felt throughout the economy, according to Zandi - he has shaved a quarter point off his projected economic growth because of housing related issues.

But some local markets will suffer far more. Nationwide, about one in 10 jobs is housing related. On the west coast of Florida, however, the most housing industry dependant area in the nation, one of every five jobs is housing related.

As for the national picture, Zandi evaluated several risks to the accuracy of his housing market outlook. Some of them could have positive impacts on markets, such as if the Fed lowered interest rates.

Another positive would be if lenders, mortgage servicers and investors in mortgage backed securities were able to increase their loan modification efforts. These are concessions made to mortgage borrowers that would alter the terms of their loans, even lower payments, and enable them to keep their homes.

Negative risks would include some kind of shock to the global economy. "Until quite recently," said Zandi, "investors have been nonchalant about risk; they are still quite tolerant of it."

A shock, such another major hedge fund meltdown, as two Bear Stearns funds recently experienced, could cause a "crisis of confidence," according to Zandi and usher in a period of "investor freeze" leading to lower liquidity. "And credit," he said, "is the lifeblood of the economy."