Addressing Foreclosure Federal Reserve Bank of Dallas

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					                             Banking and Community
   ISSUE 2 2007
                             F E d E r a l   r E S E r v E   B a n k   o F   d a l l a S

In this issue:

Quantifying the
                             Preserving Homeownership
Foreclosure Issue
                             Addressing Foreclosure
Study of Texas

A Neighborhood’s Story

Mortgage Industry

Modernizing the FHA

Foreclosure Timeline

  S         hould we
close down the subprime
market?... Regrettable
foreclosures notwith-
standing, three-quarters
of new homeowners are
making their payments,
building wealth and
participating in the
American Dream.
       —Edward Gramlich
          Former Governor
     Federal Reserve Board
       ISSUE 2 2007
   Banking and
                                                    ncreasingly, foreclosure has become a national problem and a center of

                                            attention for Congress, regulators, the mortgage industry and consumer advo-
                                            cates. The residential foreclosure rate in Texas has been on the increase since
Perspectives                                late 2001, most notably concentrated in subprime adjustable rate mortgage
Federal Reserve Bank of Dallas
Community Affairs Office                    (ARM) loans. Many efforts to prevent homeowners from facing the financial
P.O. Box 655906
Dallas, TX 75265-5906
                                            and personal disaster of foreclosure have been implemented, and many more
Gloria Vasquez Brown
Vice President, Public Affairs
                                            measures are being proposed.
Alfreda B. Norman
Assistant Vice President and
                                                Research shows that about half of homeowners fail to seek help when they
Community Affairs Officer                  find themselves at risk of foreclosure and that the stress from being delinquent
Wenhua Di
Economist                                   on their mortgage interferes with their ability to strategize and make rational

Julie Gunter                                decisions about how to deal with financial crises.
Senior Community Affairs Advisor
                                                In June, the Federal Reserve Bank of Dallas, in partnership with the Dal-
Jackie Hoyer
Houston Branch
Senior Community Affairs Advisor            las Field Office of the Department of Housing and Urban Development (HUD),

Roy Lopez                                   hosted a conference to examine the data trends, patterns and potential impact
Community Affairs Specialist                       of foreclosure as well as industry innovations being used to reach troubled
Elizabeth Sobel
Community Affairs Specialist                borrowers and sustain homeownership. This issue of Banking and Community
Editor: Jennifer Afflerbach                 Perspectives recaps the conference by highlighting a portion of the research
Designer: Darcy Melton
Researcher and Writer: Julie Gunter
                                            and innovative solutions presented.
October 007
The views expressed are the author’s and
should not be attributed to the Federal
Reserve Bank of Dallas or the Federal
Reserve System. Articles may be reprinted
if the source is credited and a copy is
provided to the Community Affairs Office.
                                            alfreda B. norman
This publication and our webzine,           assistant vice President and Community affairs officer
e-Perspectives, are available on            Federal reserve Bank of dallas
the Dallas Fed website at

Cover Photo:
Courtesy of NeighborWorks America and
the Ad Council.

              Banking and Community Perspectives                                                    Federal reserve Bank oF dallas
Preserving Homeownership                                                                                Table 1
                                                                                                        Top County Foreclosure Rankings
Addressing Foreclosure                                                                                  in Texas
                                                                                                                               Total foreclosures      Foreclosures/
                                                                                                         Rank     County       1/1/2002 to 6/30/2006   mortgages

                                                                                                         1        Dallas       	    15,406             	   5.6%
                                                                                                         2        Bexar        	     6,040             	   3.3%
                                                                                                         3        Travis       	     3,327             	   3.1%
                                                                                                         4        Harris       	    12,689             	   3.0%
                 he conference “Preserving         (ARMs), and of those, 17 to 20 percent are            5        Cameron      	       706             	   3.0%
Homeownership: Addressing the Foreclosure          interest-only loans.                                  6        El	Paso      	     1,547             	   2.1%
Issue,” held in Dallas in June, opened with              In Texas, as in the U.S., foreclosure
                                                                                                        SOURCE:	Elizabeth	Mueller/Texas	Department	of	Housing	and	
a panel of Texas researchers who addressed         inventory rates on prime mortgages as of             	       Community	Affairs	report,	2006.

the impact foreclosures are having on the U.S.     fourth quarter 2006 were running at histori-
and Texas economies.                               cal norms—one loan foreclosure for every
                                                   200 loans, or 0.5 percent. In contrast, the        Study of Texas Foreclosures
Framing the Issue                                  subprime loan foreclosure inventory rate was             Elizabeth Mueller, assistant professor
      The first several years of this decade may   much higher, at about eight foreclosures for       at the University of Texas at Austin, led an
prove to be the “great housing experiment          every 200 loans, or 4 percent. Because 75          advisory committee to the Texas Department
of the 21st century,” according to James P.        percent of all subprime loans were origi-          of Housing and Community Affairs (TDHCA)
Gaines, a research economist with the Real         nated after 2003, Gaines said, this situation is   in a study of Texas foreclosures. Mandated by
Estate Center at Texas A&M University.             expected to be compounded over the next            the 2005 Texas Legislature, the study exam-
      Homebuyers in the U.S. have enjoyed          two years as interest rates on many of these       ined mortgage foreclosure activity in six Texas
historically low interest rates, record home       subprime loans are scheduled to increase.          counties: Bexar, Cameron, Dallas, El Paso, Har-
price increases in selected areas, and a flood     (See box “Quantifying the Foreclosure Issue.”)     ris and Travis (Table 1).
of private capital from Wall Street that led to          Gaines emphasized that the subprime                The TDHCA report included total number
easy credit terms and nontraditional mort-         story is not all bad. Even if the foreclosure      of foreclosures for 2002 to mid-2006 and
gages, Gaines said. These conditions have          rate climbs to 10 percent of all subprime          mapped data from 2004 to mid-2006 to deter-
also resulted in a surge in vacation home          loans, that means 90 percent of the families       mine where foreclosures are concentrated.
purchases and extraordinary investor demand        who financed with subprime loans are still               Texas ranked sixth nationally during this
for residential housing. The major impact of       living in their own home—a home they may           period in number of foreclosures compared
the housing experiment was an astounding           not have been able to own otherwise.               with number of households holding a mortgage.
increase in the national homeownership rate
from 64 percent in 1994 to 69 percent today.
      Gaines also pointed out that the current
results of the experiment are record home
price decreases in some areas, accompanied
by high levels of foreclosures. The main
factor leading to higher foreclosures was
relaxed underwriting standards coupled with
nontraditional loan products, according to
Gaines. To quantify the subprime situation, he
explained that about 65 percent of owner-
occupied homes in the U.S. have a mortgage.
Of those mortgages, 76 percent have fixed
interest rates and 86 percent are priced at
prime—the rate available to homebuyers with
the best credit. Of the roughly 14 percent of
mortgages considered subprime—priced at
higher interest rates than prime loans—more
than half are adjustable-rate mortgages
                                                   Photo: roy lopez

Federal reserve Bank oF dallas                                                                Banking and Community Perspectives                                       
      Every lender will agree that

      foreclosure is a lose–lose

      situation for all involved.

                                                    Photo: roy lopez
      Mueller explained that past studies have                         age points above prime mortgages).                       minority rate (80 percent or more) had the
cited several possible causes of foreclosure.                                In summary, Mueller said, the study                largest shares of high-cost mortgages, which
These include length of the foreclosure pro-                           shows a critical need for financial education.           accounted for 64.2 percent of all refinance
cess, economic conditions such as job loss,                            Foreclosures are more likely in neighbor-                loans and 56.7 percent of all home purchase
family breakup and high debt load relative to                          hoods where the average income is below                  loans. In contrast, the predominantly white
income. The committee attempted to assess                              median and lack of education may put bor-                neighborhoods (80 percent or more) had the
the importance of these factors in explaining                          rowers at a disadvantage in navigating the               lowest share of high-cost mortgages, which
the high rate of foreclosure in Texas.                                 lending process. Concentrated foreclosure                accounted for 23.2 percent of all refinance
      Texas has the worst average credit score                         activity has severe consequences for residents           loans and 13.8 percent of all home purchase
in the U.S., which could result in Texans pay-                         and communities, may indicate abusive prac-              loans.
ing higher interest rates on mortgage loans.                           tices, and shows the need for more research                   Yu compared the characteristics of the
Mueller pointed out that a loan applicant                              to determine the causes of foreclosure and               subdivision’s census tract with the average
with the average Texas credit score of 648                             possible solutions.                                      features of all census tracts in Bexar County
(compared with a national average score of                                                                                      (Table 2).
675, according to Experian’s National Score                            One Neighborhood’s Story                                      The subdivision is in a census tract with
Index) would likely fall between being quali-                               Assistant Professor Olivia Yu presented             an above-average minority rate, moderate
fied for a prime ARM and a subprime fixed                              findings from her case study of a specific San           median income, more new homes and an
rate. “That really sums it up,” Mueller said. “A                       Antonio neighborhood with a very high fore-              above-average rate of owner-occupied homes.
lot of people in Texas are right on the edge                           closure rate. The project originated when a              This census tract’s foreclosure rate was four
between subprime and prime.”                                           student in her class at the University of Texas          times the average of all census tracts in the
      When Texas’ short, nonjudicial foreclo-                          at San Antonio’s College of Public Policy                San Antonio area. The area with the worst
sure process was compared with other states                            voiced concern about a neighborhood of new               foreclosure record in the census tract was the
that have longer processes involving court                             homes that had already shown an alarmingly               subdivision Yu and her students observed.
hearings, there was not a clear pattern of                             high foreclosure rate before construction was            By the time the case study was completed,
more foreclosures in states with shorter time                          complete. Under Yu’s supervision, the student            almost 28 percent of the homes in the subdi-
frames. Therefore, the length of the process                           conducted independent re-
was not considered a factor. (See box “Texas                           search to identify the extent and
Foreclosure Timeline.”)                                                possible cause of the neighbor-
      Mueller’s committee mapped foreclo-
                                                                                                               Bexar County Census Tract Comparison
                                                                       hood’s foreclosure problem.
                                                                                                                                            Mean of 276   Census tract where the
sures by census tract to reveal any insight into                            As background, Yu ex-                          Variable         census tracts subdivision is located

the causes of foreclosure. The map for Dallas                          plained that San Antonio has             Median	income,	N	=	275        $44,570           $32,025

County, the county with the highest fore-                              enjoyed a high rate of housing           Below	poverty	rate,	N	=	275    16.9%              17.4%

closure rate, shows most foreclosures were                             growth for more than a decade,           Minority	rate                  64.8%              79.4%

concentrated in areas with incomes below 90                            averaging a 40 percent annual            Black	rate                      7.1%              25.2%

percent of median county income, 22 percent                            increase in single-family permits        Hispanic	rate                  54.7%              49.9%

or more high school dropout rate and a ma-                             in the past 15 years.                    Homeownership	rate             57.3%              67.0%

jority minority population. In addition, at least                           An analysis of 2005 Home            Median	house	age               29.1	years         15.0	years

24 percent of the loans in these areas were                                                                     Foreclosure	rate,	N	=	275       4.1%              15.5%
                                                                       Mortgage Disclosure Act data
made at high interest rates (high-cost loans                           for San Antonio showed that             SOURCE:	Olivia	Yu.
typically have interest rates at least 3 percent-                      neighborhoods with the highest

Federal reserve Bank oF dallas                                                                                         Banking and Community Perspectives                          
                                                                         ian looking out for the borrower in the            defaults and a loan is foreclosed.
  Figure 1
                                                                         complex home mortgage process. She cited                 Some of the incredible boom in home
  Distribution of Foreclosed Loans in                                    the state of New York, where buyers must           mortgage lending was due to refinance activ-
  One Troubled Neighborhood                                              pay a lawyer to represent them in the home         ity, Derstine said, but a lot of the lending
                 Intact by 3/05          Foreclosures by 3/05
  Percent                                                                loan transaction. “It costs about $300, but        was for home purchases as borrowers took
     100                                                                 it’s worth it,” she said.                          advantage of historically low interest rates
               51.1               27           26.3                                                                         and especially low short-term financing rates
      80                                                                 Mortgage Industry Response                         in 2002 and 2003. Rates began rising in 2004
                                                                               Every lender will agree that foreclo-        and 2005, and the incentive to refinance
      60                                                                  sure is a lose–lose situation for all involved.   disappeared. Home prices leveled off in 2005
                                                                          The conference included presentations             and 2006, and loans began aging into “peak
      40                                                                  from large and small mortgage lenders and         loss years,” typically three-plus years after
               48.9           73               73.8             86.4      servicers, the secondary market and the           origination. RMIC analysis found that Texas
                                                                          mortgage insurance industry. Many of these        has a high proportion of loans to borrowers
                                                                          organizations are partnering with nonprofit,      with lower credit scores and higher loan-to-
              ARM            Conv.                 FHA           VA       community-based service providers to reach        value ratios, which also impacts the state’s
                                       Loan type
                                                                          troubled homeowners and raise awareness           foreclosure rates.
  SOURCE:	Olivia	Yu.                                                      of the various alternatives to foreclosure.             The current trend in Texas is stabiliza-
                                                                               Created by the federal government in         tion of defaults, according to Derstine. He
vision had been foreclosed. Further, and just                             1938, Fannie Mae is now the largest buyer         mentioned these positive signs: low unem-
as troubling to homeowners who remained in                             and guarantor of mortgages in the United             ployment rates, house price appreciation,
the neighborhood, home values had dropped                              States. Steve Horne, director of servicing           moderate inventory levels, slowing of new
by almost 13 percent.                                                  risk strategy for Fannie Mae’s Dallas office,        construction, and less use of high-risk ARMS
      Of the 306 loan originations in the                              explained that Fannie Mae is working with            and other products. “While we are still seeing
subject neighborhood, 14.7 percent were                                national and community-based nonprofits,             relatively high foreclosures, given these fac-
high-cost ARMs. The distribution of foreclosed                         in addition to lenders, loan servicers and           tors, we hope the market is not introducing
loans by loan type is illustrated in Figure 1.                         mortgage insurers, on strategies to increase         any new problems into the mix.”
      More than two-thirds of the 86 foreclo-                          homeownership retention rates.                             RMIC is reviewing its loans, identifying
sures took place within three years of the                                   Horne echoed a statement by many               those with upcoming interest rate resets and
loan origination. Yu said that, according to                           presenters at the conference: “The trick is          finding ways to solve problems before they
the Department of Housing and Urban Devel-                             reaching the borrower earlier in the pro-            occur. The company is also conducting regu-
opment, “foreclosures filed within two years                           cess.” Fannie’s new HomeStay initiative is a         lar reviews with lenders, providing analytical
of the loan origination are strong indicators of                       combination of technology (underwriting              tools and guidance on portfolio risks, and
fraudulent and abusive lending practices.”                             systems), alternative loan options for refinanc-     encouraging prudent practices through strong
      The research team found it extremely                             ing subprime mortgages, and outreach to              credit policies.
difficult to reach families that had lost their                        loan servicers and nonprofits. According to a              As senior vice president of Wells Fargo
homes to foreclosure. In the end, six families                         recent update on the HomeStay initiative by          Home Mortgage, Stephanie Christie is an
agreed to be interviewed. One experience                               Fannie Mae President and CEO Daniel Mudd,            executive for one of the largest mortgage
that four families had in common was that                              about 70 percent of Fannie’s applications for        lenders and servicers in the U.S. Despite the
their property taxes were not assessed as im-                          refinancing of subprime mortgages have been          current controversy, Wells Fargo is commit-
proved property at the time of closing, result-                        approved. This means over $6 billion in refi-        ted to responsible nonprime lending, Christie
ing in a shortage in their escrow account of                           nancing and approximately 33,000 homeown-            said. She referenced a recent New York Times
approximately $2,500 by the end of the first                           ers served.                                          article that claimed an increase in minority
year of their loan. Of these families, only one                              Republic Mortgage Insurance Co. (RMIC)         homeownership was directly attributable to
stated that the lender had mentioned that the                          is a national provider of private mortgage           an increase in subprime lending options.
property tax was based on the land value but                           insurance. Michael Derstine, pricing group                 The Wells Fargo Steps To Success
had not explained why and what difference it                           manager for RMIC, explained that the mort-           program offers upfront education for all
would make.                                                            gage insurer’s role is to protect lenders from       nonprime borrowers—those with less-than-
      Yu identified one obvious problem                                financial losses due to defaults on high loan-       perfect credit or low use of credit, Chris-
based on this study. In Texas, there does                              to-value mortgages. As Derstine put it, “We          tie said. The program is also provided to
not appear to be a single, qualified guard-                            feel the pain directly” when a homeowner             homeowners with loans made by Wells’ joint

          Banking and Community Perspectives                                                                               Federal reserve Bank oF dallas
venture partners. Through March 2007, over             Tips for Avoiding Foreclosure                    strongest FHA state in the country, FHA loan
30,000 households were enrolled in Steps To                                                             originations are down 34 percent from 2001
Success. The program has three elements:               • Don’t	ignore	the	letters	from	your	lender.     through 2006.
                                                       • Contact	your	lender	immediately.                    Montgomery believes that modernizing
     • Credit cleanup. Borrowers receive a free
                                                       • Understand	your	foreclosure	prevention	        the FHA will provide sound and affordable
       credit report, including credit score and
                                                         options.	Go	to:	                               refinance alternatives to people who have
       tips on how to keep credit sharp.
                                                             “gotten in over their heads” with more exotic
     • Hands on Banking, a financial educa-
                                                       • Contact	a	HUD-approved	housing	counsel-        loan products.
       tion program, enhanced to include live
                                                         ing	agency:	                                        Some of the proposed FHA improve-
                                                         Toll-free	800-569-4287	                        ments include:
     • Information about automatic payment
                                                         TTY	800-877-8339
       enrollment and other banking services.                                                             • Lowering the down payment require-
                                                                                                            ment (FHA currently requires 3 percent).
After one year of making payments on time          Fuhrman suspects Texas caller volume will
                                                                                                          • Establishing mortgage insurance premi-
through automatic payment, the borrower            go even higher because of efforts in the state
                                                                                                            ums based on the borrower’s ability to
receives recognition and a small monetary          to promote the hotline and homeownership.
                                                                                                            repay the loan.
reward. Although early in the process, Wells       For example, following a press conference
                                                                                                          • Lengthening the available loan terms
Fargo is seeing positive results:                  organized by the Dallas HOPE partnership on
                                                                                                            from 30 to 40 years.
                                                   June 6 in Arlington, call volume from Texas
     • Participants in Steps To Success are sig-                                                          • Increasing loan limits.
                                                   temporarily jumped from 30 calls per day to
       nificantly more likely to be enrolled in                                                           • Eliminating the cap on the number of
                                                   over 250 per day.
       automatic mortgage payment programs.                                                                 Home Equity Conversion Mortgages that
                                                         Lenders and others are supporting HPF
     • Visits to the Hands on Banking web site                                                              FHA insures.
                                                   efforts to increase awareness of the toll-free
       have increased 100 percent, and much
                                                   number nationwide. Because early interven-                The most frequent recommendation
       of this increase can be attributed to the
                                                   tion is critical and some homeowners are re-         made by speakers at the “Preserving Home-
       Steps To Success program.
                                                   luctant to make their first call for help to their   ownership” conference was to increase com-
     • Fewer delinquencies occur among
                                                   lender, some lenders are printing 888-995-           munication channels to borrowers earlier in
       program participants than among a
                                                   HOPE on their monthly mortgage statements            the delinquency process as the key to reduc-
       larger sample of nonprime customers
                                                   and delinquent letters.                              ing foreclosures.
       (including 30, 60 and 90 days delinquent
                                                         Not all success can be gauged by                    One national initiative to achieve earlier
                                                   homeownership retention, Fuhrman said.               intervention is NeighborWorks America’s new
      Josh Fuhrman is director of counseling       Sometimes the result of a successful coun-           public service announcement, designed by
for the national nonprofit Homeownership           seling effort is helping borrowers see that          the Ad Council. The message, “Nothing is
Preservation Foundation (HPF), which bridges       homeownership is not for them or not realis-         worse than doing nothing,” is accompanied
the communication gap between homeowner            tic given the circumstances. In those situa-         by the HPF counseling hotline number. The
and lender. HPF provides a toll-free consumer      tions—perhaps in the case of divorce or loss         radio and TV message has been distributed to
hotline (888-995-HOPE) with counselors             of income—homeowners are encouraged to               media outlets in Texas and across the country.
available 24 hours a day, seven days a week        consider other options, such as a short sale,             With thousands of Texas homeowners
to help homeowners with their mortgage dif-        which gives them a graceful exit from the            facing interest rate adjustments in the coming
ficulties. If face-to-face counseling is needed,   home but still avoids the devastating effect of      months, the mortgage industry and consumer
the homeowner is referred to a local, non-         a foreclosure on their credit record.                advocates are hoping they will heed the
profit counseling agency.                                                                               advice.
      HPF has worked with over 100,000             Modernizing the FHA
consumers since the nonprofit was founded                Federal Housing Commissioner Brian D.               More information and presentations from
in 2004, and almost a third of those were          Montgomery’s remarks concentrated on the             the Federal Reserve Bank of Dallas conference
counseled in the first five months of 2007.        Federal Housing Administration (FHA) having          “Preserving Homeownership: Addressing the
The hotline’s current call-in rate is 600 calls    fallen behind the times. Without a modern-           Foreclosure Issue,” June 12, 2007, are available
per day, compared with 200 per day last year.      ized FHA product, many first-time homebuy-           at
      HPF counseled 1,500 Texas homeown-           ers have been left without safe, affordable
ers in 2005 and 3,000 in 2006. It anticipates      mortgage options and have instead turned to
6,000–8,000 calls from Texas in 2007.              subprime loans. Even in Texas, which is the

      Banking and Community Perspectives                                                               Federal reserve Bank oF dallas

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