For many owners of high-end homes, their strategy backfired when the market for jumbo mortgages dried up
(NEW YORK) Chuck Dayton put down a quarter of the US$950,000 purchase price when he bought his house in Newport Beach, California, in 2004. He was making US$500,000 a year with his drywall company and he expected home values to keep rising.
Then the mortgage market collapsed, new construction stopped and builders no longer needed his services. Mr Dayton, 43, went into default four months ago because he could not afford payments on the three-bedroom home, located within a block of the Pacific Ocean. He hopes his lender will agree to sell the seven-year-old house for less than he owes to avoid a foreclosure. 'It's just wait and see right now,' he said.
Borrowers such as Mr Dayton, whose 2004 compensation was almost 10 times the median US household income, are becoming trapped by the same issue facing the poorest sub-prime homeowners: falling home prices erase equity and make it impossible to sell or refinance without losing money.
The number of US homes valued at more than US$729,750 - the jumbo-loan limit in the most affluent areas - entering the foreclosure process jumped 127 per cent during the first 10 weeks of this year from the same period of 2008, data compiled by RealtyTrac Inc of Irvine, California, show. The rate rose 72 per cent for homes valued at less than US$417,000 and 78 per cent for all homes, RealtyTrac said.
'It's the trickle-up effect,' said David Adamo, chief executive officer of Luxury Mortgage Corp, a home-loan bank in Stamford, Connecticut. 'Just like homeowners in smaller homes, these homeowners anticipated being able to refinance mortgages to continue making payments and at a future date, sell for a gain and put it toward their next home. That strategy backfired when the market for jumbo mortgages dried up.'
Jumbo loans are larger than what government-controlled Fannie Mae and Freddie Mac will buy or guarantee, currently US$417,000 in most areas. Jumbo lending slowed in the fourth quarter to US$11 billion, or 4 per cent of the mortgage market, the lowest quarterly figure since Inside Mortgage Finance started tracking the data in 1990.
Sub-prime loans were made available to borrowers who never proved they could make monthly payments on time. The loans accounted for more than 20 per cent of the US mortgage market in 2005, up from less than 8 per cent in 2003, according to Inside Mortgage Finance.
Defaults by sub-prime borrowers began rising in 2007. Since then, financial institutions that had bet on earning cash flow from home loans packaged into securities have announced credit-market losses and writedowns of almost US$1.4 trillion, data compiled by Bloomberg show.
The US government has lent banks US$392 billion to stem the losses through its Troubled Asset Relief Program. Another US$12.4 trillion was spent, lent or guaranteed by the government and the Federal Reserve to stop the longest recession since the 1930s.
About US$500 billion of prime-jumbo mortgages are bundled into bonds, according to FTN Financial. In February, JPMorgan Chase & Co analysts John Sim and Abhishek Mistry in New York almost doubled their projections for losses on those mortgages to as much as 10 per cent because of increasing defaults.
Foreclosures have come to the Hamptons, the beach towns east of New York City on Long Island, where homeowners have included Blackstone Group LP chief executive officer Stephen Schwarzman, hedge fund manager John Paulson and Goldman Sachs Group Inc CEO Lloyd Blankfein.
Almost 90 borrowers entered the foreclosure process in the towns of East Hampton and Southampton in the first 10 weeks of this year. That compared with 109 in the same period last year and 73 in the first 10 weeks of 2007, according to the Real Estate Report in West Islip, New York.
Home sales in the Hamptons fell 67 per cent in the first quarter from a year earlier, the most since records were first kept in 1982, according to Town & Country Real Estate of the East End LLC. The median sale price slid 28 per cent from a year earlier.
Rule changes spurred by rising defaults now require lenders to work with delinquent New York homeowners before beginning the foreclosure process, said Pat Ammirati, president of the Real Estate Report.
'There was this unrealistic view that the crazy financing was limited to sub-prime when of course it was across the board,' said Andrew Laperriere, Washington-based managing director at research firm International Strategy & Investment Group. 'A lot of jumbo mortgages were nothing down with high debt-to-income ratios.'
Mr Dayton said that he financed the purchase of his home with a payment-option adjustable-rate mortgage now serviced by JPMorgan's Washington Mutual. The option allowed him to pay less each month than the interest on the loan, with any unpaid amount added to his debt.
He refinanced in February 2007 with a US$1 million loan from Washington Mutual, and used some of the proceeds for business expenses, said Robin Milonakis, his agent at Altera Real Estate in Dana Point, California. He also took out two private mortgages and now has a balance of US$106,000 on those loans, she said.
Mr Dayton went into default on Jan 29 and owes US$46,584 in delinquent payments and penalties, according to First American CoreLogic, a Santa Ana, California-based mortgage data firm. Mr Dayton said that he has found a buyer willing to pay US$950,000. The foreclosure process typically takes about a year. That means jumbo-loan defaults, which are climbing at the fastest pace in at least 15 years, will increase over the next year, according to LPS Applied Analytics in Jacksonville, Florida.
President Barack Obama's Homeowner Affordability and Stability Plan has no provision to help jumbo-mortgage borrowers. The plan focuses on shoring up home loans eligible to be bought by Fannie Mae and Freddie Mac, also called conforming loans.
'The government has thumbed their noses at people who have jumbo mortgages,' said Steve Habetz, president of Threshold Mortgage Co in Westport, Connecticut.
The share of US homes in the foreclosure process that are valued at more than US$729,750 increased to 2.83 per cent this year through March 10, from 2.21 per cent in the same 10 weeks of 2008, according to RealtyTrac. In the same 10-week period, the share of homes valued at US$417,000 or less in foreclosure fell to 87 per cent from 89.7 per cent in 2008, RealtyTrac said.
California is hardest hit by luxury-home foreclosures. More than 1,500 borrowers with properties in the state that once sold for more than US$1 million defaulted on their mortgages in February, said Mark Hanson, managing director of the Field Check Group, a real estate company in Palo Alto,
About 3 per cent, or 254,745, of the state's 8.5 million houses are assessed for more than US$1 million by county assessors, according to San Diego-based MDA DataQuick, a real estate monitoring company.
While sales for all homes in the state increased 2.5 per cent last year from 2007, sales of homes valued at more than US$1 million declined 43 per cent to the lowest since 2003, MDA DataQuick reported. Part of the reason is falling prices as California's median home price dropped 41 per cent in February to US$247,590, according to the state's Association of Realtors. Another explanation may be stricter lending guidelines, Mr Hanson said.
'You have to have income of US$250,000, a 20 per cent down payment and near perfect credit to buy a US$1 million home now, so the number of buyers isn't what it was,' Mr Hanson said. 'There just aren't enough buyers to sop up supply. We're seeing the collapse of the high-end market.'
Values have taken longer to decline in more affluent areas, taking some homeowners by surprise, said Philip Tirone, president of Los Angeles-based Mortgage Equity Group Inc.
'People are coming to me to do a refinance or buy another property, and what they thought they had in the equity of the home they don't have and they don't know what to do,' he said.
Delinquencies are caused by people who owe more on their mortgages than their houses are worth, said James McLauchlen, a broker and appraiser in Southampton, New York, for James R McLauchlen Real Estate Inc and Hamptons Appraisal Service Corp.
'They throw their hands up and say I'm not going to kill myself trying to take care of this debt,' Mr McLauchlen said. 'Some folks work hard to make payments. Others just can't pay. They offer a deed in lieu of foreclosure and off they go.'
Mr Dayton said that he does not know when he'll restart his drywall business, which he shut down in November for lack of work. 'This market is not even close to bottoming out, in my opinion,' he said. 'It continues to drop.' - Bloomberg
Source: Business Times, 7 May 2009