Subprime creep: From city to burbs

Cleveland's foreclosure crisis is no longer a problem that's just for the poor.

In the city's central neighborhoods, it's been common for years: Low-income homeowners living on a financial edge were also preyed on by abusive lenders during the nation's recent housing bubble.

But now the mess has spread to Cleveland's wealthy suburbs, where delinquency filings have exploded over the past year despite residents' relative prosperity and supposedly higher education levels. The numbers are even beginning to eclipse those of the city.

In Shaker Heights, the model of an affluent Midwestern suburb, the problem "is huge," said Mark Seifert, executive director of the East Side Organizing Project (ESOP), a community advocacy group in Cleveland.

Foreclosure rescue: Saving a home

Foreclosure filings in its 44118 ZIP code nearly tripled to 910 in the first 10 months of 2007 from 334 during the same period a year ago, according to RealtyTrac. But the foreclosure rate in Cleveland proper, while still among the highest in the nation, has slowed down, although filings have doubled over the same period.

ESOP clients coming in for foreclosure counseling are much more likely to be from the suburbs than in the past, according to Seifert. Last year, about a fifth of them came from outside the city limits. Today, "It's upward of 40 percent," he said, "approaching 50 percent."

Mark Wiseman runs the foreclosure prevention program for the Treasurer's Department of Cuyahoga County, which includes Cleveland and many of its suburbs. "A lot of suburbs," he said, "especially the ones that border the city, mirror the city's problems. The lending problems are the same."

But suburban families, with more assets and income, tend to be a little more insulated from immediate default triggers. They may have been able to refi one more time and temporarily push foreclosure back. Many Cleveland city dwellers have fewer resources to tap to stay in their home.

Simple geographical progression is also to blame, according to Wiseman. Foreclosures lowered property values around inner-city homes and spread out from the center as Cleveland's economy stagnated.

Where Cleveland went wrong

And with a nationwide drop in home prices, a slowdown in sales and a rise in inventories, greater Cleveland's wealthy homeowners are now feeling the pinch like everyone else. The typical home in the metro area sells for about 4.2 percent less than it did a year ago, according to the National Association of Realtors.

By themselves, price drops can cause foreclosure jumps. When prices were high, borrowers could buy with low down payments or refinance their old homes. But when prices fell, many homeowners found themselves owing more than their homes were worth.

And when that happens, no matter how wealthy the neighborhood, many simply turn the keys over to their lenders or do a short sale where they unload their houses for what the market will bring,

Wiseman reported that on his block in University Heights, a solidly middle-class suburb, there have been two sheriff sales this year and four houses are vacant. "About 40 percent of the homes on the block are for sale," he said.

Lakewood is a densely populated town on the shore of Lake Erie. Scene, a local magazine, rated it as the Cleveland area's best city to live in. Filings tripled in its 44107 ZIP code to 572 from January to October, compared with a year ago.

In working-class Maple Heights, RealtyTrac recorded 1,165 foreclosure filings through the first 10 months of this year in zip code 44137 for a rise of 168 percent.

Foreclosure rescue: No help for you.

And in Parma, another close-in community south of central Cleveland, foreclosure filings totaled just 190 in the first 10 months of last year but blew up to 1,159 for the first 10 months of this year, for a 510 percent spike.

Three years ago, Seifert tried to enlist some of the city's inner-ring suburbs in the fight against foreclosures. But, he said, his attempts at outreach fell upon mostly deaf ears.

"The responses ranged from 'We're really not interested' to 'How dare you suggest that,'" said Seifert. The general attitude was "We've got it under control."

Six months after his first overtures, one suburb, Warrensville Heights, invited him to give a presentation about foreclosure prevention counseling before town officials.

And now, most of the inner ring suburbs are coming around, according to Seifert. They had to

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Senate OKs subprime aid bill

The Senate moved Friday against the worsening mortgage crisis, voting to make it easier for thousands of homeowners with ballooning interest rates to refinance into federally insured loans.

The legislation, approved 93-1, would allow the Federal Housing Administration to back refinanced loans for borrowers who are delinquent on payments because their mortgages are resetting to sharply higher rates from low initial "teaser" levels.

The bill also tries to make FHA loans more attractive than risky subprime loans by accepting lower down payments and expanding the eligibility for counseling for homeowners having difficulty with their mortgage payments.

An estimated 2 million to 2.5 million adjustable-rate mortgages are scheduled to reset in the next year, jumping to much steeper rates that could cost borrowers their homes. The wave could crest during the presidential and congressional election campaigns next year, and politicians have been wrestling with what the government's response should be.

The Senate's proposed changes are especially important now, given the credit crisis that has made it much more difficult and more expensive for people to refinance or get financing to buy a home. Private lenders have been reluctant to make new loans.

Allowing the federal government to insure more and bigger loans should help provide some relief and ease the credit crunch.

The Senate's plan would give homeowners "the option of refinancing to an FHA-backed loan with the peace of mind that comes with it," said Senate Majority Leader Harry Reid, D-Nev. "And for future homebuyers, a fully backed FHA loan with honest, upfront terms, will help prevent crises like we now face."

Modernizing the FHA is Congress' first attempt at stand-alone legislation to ease the subprime mortgage mess. The House passed a bill similar to the Senate's back in September, but a final measure probably won't be ready for President Bush's signature until next year.

Meanwhile, the White House last week announced it had negotiated an agreement with mortgage companies to freeze interest rates for certain subprime mortgages for five years.

White House Press Secretary Dana Perino said the Senate bill "would give FHA some of the additional flexibility it needs to provide more families with a safe, affordable mortgage financing option." She said, however, that the president still has some concerns about the bill.

The Senate bill raises the maximum mortgage the FHA can insure in high-cost areas like California and the Northeast from $362,790 to $417,000 - the same level as loans backed by Fannie Mae and Freddie Mac.

The House would raise the maximum mortgage to $729,750 in high-cost areas, with the higher limit a point of contention between the House, Senate and the White House.
A low, low interest rate of 396%

The Senate bill would also lower the FHA down payment requirement from 3 percent to 1.5 percent, depending on an assortment of factors - and make it easier for FHA loans to be used to buy condos.

"It is good before the Christmas season we have made a down payment on the solution to this problem," said Sen. Mel Martinez, R-Fla.

The legislation will help the FHA "be a source of salvation for those families who were tricked into unaffordable loans," said Sen. Charles Schumer, D-N.Y.

The only senator to vote against the bill was Sen. Jon Kyl, R-Ariz.

Many homeowners have been looking for help from the government this year. Of the nearly 3 million subprime adjustable-rate loans surveyed by the Mortgage Bankers Association in the third quarter, a record 18.81 percent of them were past due. A record 4.72 percent of the loans entered into the foreclosure process during that period.

Modernizing the FHA "will have an immediate impact helping some distressed borrowers who are having trouble paying their current mortgages avoid foreclosure," said David G. Kittle, the association's chairman-elect.

The nonpartisan Congressional Budget Office estimated that the Senate's changes would result in an 8 percent increase in FHA loans - $4 billion annually in additional loan guarantees - over the next five years.

The agency, which has provided mortgage insurance since 1934, currently insures 3.7 million mortgages.

The FHA has been pushing Congress for years for the ability to guarantee more loans, saying the size of mortgages the government agency can back is often too small to attract borrowers in expensive areas. As a result, FHA's share of the single-family mortgage market has dropped to about 4 percent, down from 19 percent more than 10 years ago.

But most of the increase would not come from people in high-cost areas, the CBO said, but in the less expensive housing markets, where maximum mortgages would be going up from $200,160 to $271,050

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A low, low interest rate of 396 percent

At the East Side Organizing Project in Cleveland, six home owners recently went in for group foreclosure counseling. When asked if any had taken out payday loans, four hands shot up.

A payday loan is a small-dollar, short-term loan with fees that can add up to interest rates of almost 400 percent. They're generally taken out when the borrower is caught short on cash and promises to pay the balance back next payday.

If it sounds like legal loan-sharking, it's not. "Loan sharks are actually cheaper," said Bill Faith, a leader of the Ohio Coalition for Responsible Lending.

The industry portrays it as emergency cash, but critics say the business model depends on repeat borrowing where the original loans are rolled over again and again.

They're available in 41 states, but they've been particularly troubling in Ohio, one of the states hit hardest by home foreclosures.

"There may be a correlation between not having the means to pay mortgages and payday loan borrowing," said republican state legislator William Batchelder, at a Thursday press conference held with the Center for Responsible Lending (CRL). Batchelder is sponsoring a bill that would cap payday loan interest rates at 36 percent.

Jim Rokakis, treasurer of Cuyahoga County, which includes Cleveland, said, "I've been to [foreclosure counseling] sessions where almost everyone raised their hands," saying they had payday loans.

One ESOP client said, "You get a payday loan and you take your pay next payday and pay back the loan. Then you don't have enough money to last to the next payday, so you go back. If you don't pay the loan, they call everybody from your employer to your sister."

Faith said he saw a sign in the window of a payday lending shop that read: "The first loan is free." The business evolved from check-cashing services. In Ohio, the number of lender locations jumped from 107 in 1996 to 1,562 10 years later.

"If you want to see what an unregulated market economy looks like," said Rokakis, "come to Ohio." There are now more payday lending shops in the state than McDonalds, Burger Kings and Wendy's restaurants combined, he noted.

Lenders only require borrowers show pay stubs, checking accounts and references. They don't credit-check, except to make sure borrowers haven't defaulted on previous payday loans.

The lenders ask borrowers for post-dated checks for the amount borrowed, plus fees, which average $15 per $100 loan. If the loan goes un-repaid, lenders deposit the checks.

The term is usually two weeks, "Most people believe they're just going to borrow the one time," said Faith. Instead, when the two weeks goes by, they often go back to the shop and roll it over for another two weeks. To do that, they pay another $45 in fees.

"It's not a two-week loan," said Uriah King, of the CRL. "Most loans are rolled over 10, 12 or 13 times. That's the business model even though the industry says it's not."

When the CRL took the average payday loan principal as reported by state regulators and multiplied it by the average number of loan rollovers per year, it found that typical borrowers pay back $793 for a $325 loan.

At least 10 million households get payday loans over the course of a year, according to the CRL. Borrowers are disproportionately minority, female and in the military. They have lower income and education levels than the general population.

Not everyone agrees that payday lending bad. "People are not complaining, CRL is complaining. Go to any state consumer complaint agency and you'll find very few about payday lending," said Steven Schlein of the Community Financial Services Association, a payday lending group.

A paper by Donald Morgan, a research officer with the Federal Reserve Bank of New York, indicates that payday lending may be preferable to some alternatives. In two states where it was banned, he found, consumers were worse off.

They're more likely to bounce checks, he found, which is more expensive than payday loans. Fees on bounced checks can carry an annual percentage rate of 1,000 percent.

But King believes that's a false comparison. "People don't knowingly bounce checks," he said. It's usually an accident, and it's illegal. "How do you take a payday loan to avoid bouncing a check?" he asked.

Most consumers who get caught short have much cheaper alternatives to payday loans, according to the CRL. Many have credit cards that could provide them with cash advances with much lower interest. Others have access to credit union loans, pay advances at work or home equity loans. Debtors can also work out delayed payments plans with creditors.

Federal and state governments have started to take aim at the industry. Last year Congress passed legislation capping interest rates on consumer loans for military personnel at 36 percent. North Carolina and Georgia have both ended payday lending. Other states like Ohio are discussing remedies like Batchelder's bill.

But the CRL doesn't believe changing state laws to fix payday lending is enough. "We've concluded that this is a defective product," said King, "that can't be reformed."

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Fed to crack down on shady lenders

People taking out home mortgages may gain new protections soon against shady lending practices as the Federal Reserve seeks to back even the riskiest borrowers, already hit hardest by the housing and credit crunches.

Rules expected to be proposed Tuesday would apply to loans made by all types of lenders, including banks and brokers. The plan from the Fed, which has regulatory powers over the nation's financial system, could be finalized next year. The effective date would be know then.

The Fed is considering:

--barring lenders from penalizing subprime borrowers - those with spotty credit or low incomes - who pay their loans off early.

--forcing lenders to make sure that borrowers, especially subprime borrowers, set aside money to pay for taxes and insurance.

--restricting loans that do not require proof of a borrower's income.

--examining lenders' failure, in some cases, to consider a borrower's ability to repay a home loan.

--improving financial disclosure so people better understand the terms and conditions of their mortgages and get this information when it is most useful.

--curtailing abuses in mortgage advertising.

"We have an obligation to prevent fraud and abusive lending," the Fed chairman, Ben Bernanke, said earlier this year. "At the same time, we must tread carefully so as not to suppress responsible lending or eliminate refinancing opportunities for subprime borrowers."

The issue has taken on heightened importance given the meltdown in the housing and credit markets that has led to record numbers of home foreclosures. The crisis has raised the odds that the economy might fall into a recession, roiled Wall Street and has given Democrats and Republicans much fodder to blame each other.

On prepayment penalties, consumer advocates say these deter homeowners from refinancing on more favorable terms. Those penalties can be hard on borrowers who want to get out of adjustable-rate mortgages that reset from a low introductory rate to a much higher one they have trouble paying off.

Mortgage industry representatives say prepayment penalties ensure that lenders receive a minimum return if loans are paid off early. They also say people with mortgages that include such penalties often get a benefit of lower upfront costs or lower interest rates.

Of the nearly 3 million subprime adjustable-rate loans surveyed by the Mortgage Bankers Association from July through September, a record 4.72 percent entered the foreclosure process during those months. At the same time, a record 18.81 percent of the subprime adjustable-rate loans were past due.

When home values weakened, borrowers were left with loans balances that eclipsed the value of their homes. They also were clobbered when their loans reset with much higher interest rates.

As for the idea of setting aside money to cover taxes and insurance, consumer groups worry that subprime borrowers do know about these expenses or might not be able to budget for them. These groups also have raised concerns about lenders quoting subprime borrowers monthly payments that do not include taxes and insurance costs.

The Mortgage Bankers Association has some problems with mandating escrow accounts - where those costs specifically are set aside each month - for borrowers. The association does support efforts to make sure borrowers have the appropriate information about their obligations to pay taxes and insurance.

The Fed says loans to subprime borrowers typically do not include such an account, while loans to people with better credit and lower risk to the lender usually do.

The central bank also says that lenders sometime will make a loan without documenting or verifying a borrower's income. Lenders may charge higher rates for such loans, the Fed says.

Mortgage lenders say these loans are appropriate for many borrowers, including those who are self-employed and cannot easily document their income. Consumer groups say many borrowers who could document their income are not aware they are getting a loan at a higher interest rate. These loans are sometimes called "liar's loans" because critics believe they can be used to perpetrate fraud.

Majority Democrats in Congress have been vocal in urging the Fed to act against abusive practices.

Massachusetts Rep. Barney Frank, chairman of the House Financial Services Committee, and other House Democrats said in a recent letter to the Fed that tougher rules are overdue and "needed to help eliminate the kinds of predatory lending practices that exacerbated the current subprime lending crisis."

The House has passed legislation that would put into law some of the same actions the Fed is considering. A similar bill is pending in the Senate. Supporters are heartened the Fed is moving ahead because they think the Fed might be able to finalize action before Congress does

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Fannie: Home prices to sink 4-5% in '08

Average home prices will decline another 4 to 5 percent in 2008, according to Fannie Mae Chief Executive Dan Mudd.

Mudd, speaking at Fannie Mae's first shareholders meeting in more than three years, said the mortgage-finance firm does not see a turnaround in the U.S. housing market until 2009 "at the earliest."

"Home sales are down, we expect more to come," Mudd said.

The median price of an existing home sold jumped 43 percent between 2001 and 2005, but year-over-year price declines started in late 2006 and are expected to fall almost 2 percent this year, according to the National Association of Realtors. That would mark the first year with a decline in prices.

The run-up in prices caused a problem with affordability in many markets, Mudd said, and prices need to retreat in order to restore affordability before a housing recovery can begin.

He blamed the growth in subprime mortgages that sparked the current credit market crisis on the affordability problems during the boom years.

"With the decrease of affordability, a lot of those products grew up to get payments down," he said. But he said that once home prices become more affordable, he expects the market to recover relatively quickly.

"There's a strong fundamental supply and demand under the market," he said.

He said the continued tough times ahead for housing and mortgage finance is the reason that Fannie (FNM) has had to take steps that have hit its share price recently, including cutting its dividend by 30 percent and the sale of $7 billion of preferred stock earlier this month to raise capital. It took the steps after reporting a $1.4 billion loss in the third quarter.

"We have to have a solid and conservative capital position to go into a market this challenging," he said.

Fannie Mae faced some criticism from shareholders at the meeting, none more so than gadfly individual investor Evelyn Davis, who dominated the questions and comments portion of the meeting, and advocated that the entire board of directors resign other than former FBI Director Louis Freeh.

"I'm a stockholder in 80 corporations. None of them have done as bad as Fannie Mae," she said. "It's time we get someone to clean up the situation."

Fannie shares gained 2 percent in trading Friday. But so far this year it has lost 40 percent of its value, which still puts it ahead of rival Freddie Mac (FRE, Fortune 500), which has seen its shares slide 52 percent year to date due to many of the same problems.

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