Story URL: http://news.medill.northwestern.edu/chicago/news.aspx?id=46965
Story Retrieval Date: 5/24/2013 8:56:45 AM CST
Ana Rodriguez and her family almost lost their home in Chicago’s Jefferson Park neighborhood last year. Their story is an example of how one Chicago family has been affected by a credit crisis that began on Wall Street but has expanded to Main Street. It’s a situation other families may soon find themselves in.
Rodriguez’s husband, Ricardo, lost his job prior to 2004, but he eventually found lower-paying work. He convinced the family to refinance into an adjustable-rate mortgage to help pay bills, but he lost his job a year later and the family fell behind in its house payments. They received a foreclosure notice in July 2006 and, had they not gotten help, their ARM would have reset with a higher interest rate in January.
An ARM is a loan that gives a borrower an introductory “teaser” interest rate that eventually resets at a much higher rate. Loan brokers often tell borrowers that they can refinance to avoid the increasing rate.
ARMs gained popularity as home prices rose and homeowners were offered easy refinancing terms during the first half of the decade. Brokers are usually paid on commission, and some of them “will serially refinance people,” said Michael van Zalingen, director of Homeownership Services at Neighborhood Housing Services of Chicago. Often brokers fail to explain the “hieroglyphics of legalese” in the loan terms, he added.
That is exactly what happened to Rodriguez. She said her broker told the family they could refinance the ARM after one year. “‘Give me a call and I’ll take care of you,’ he said. We never met this person. It was all [done] over the phone,” Rodriguez said.
The family began receiving daily visits and letters from people wanting to buy their home after their foreclosure notice was made public.
“That was very disturbing for me and my children to be in that situation,” Rodriguez said.
The family was able to refinance into a 30-year fixed mortgage with the help of counselors at NHS of Chicago and the equity they had built in their home during nine years.
Many families are not so lucky. Some Chicago neighborhoods are now riddled with boarded-up buildings as families get pushed out of their homes because they can’t pay their mortgages.
The city had 10,294 foreclosures in 2006, according to the National Training and Information Center, a nonprofit research and charity organization. NTIC is set to release its 2007 numbers in September. The number of Chicago foreclosures was 36 percent higher last year compared with 2005, and it more than doubled from 2003, according to NTIC.
The foreclosure rate could rise to between 16,000 and 17,000 this year, van Zalingen said, adding that the same numbers could apply to 2008.
More than three-quarters of all early defaults in Chicago occurred in low- or moderate-income communities. (See graphics for geographical concentrations.) An early-payment default is when a borrower defaults on a loan within the first year.
“That is going through the roof right now, and that’s the real story behind the subprime crisis,” van Zalingen said.
Yet Chicago has not been hit as hard as other cities. “Chicago’s economy is a lot more diverse,” said Philip Ashton, an assistant professor at the University of Illinois at Chicago. “So factory closings or layoffs or downsizings…don’t tend to ripple through the economy the same way they do in Michigan and Ohio.”
Foreclosures on prime loans in Chicago climbed to 46 percent of all foreclosures in 2006 from 21 percent in 2002, according to NTIC. Prime loans are typically given to consumers with credit scores of 700 or higher on a scale of 350 to 850.
Van Zalingen said the percentage of people who probably shouldn’t have gotten a loan in the first place is between 40 percent and 60 percent of those seeking foreclosure services at NHS.
During the nation’s housing boom in the first half of the decade, the lending industry grew as mainstream banks and lending companies began to make more and more loans in the subprime market. One well-known subprime loan is the 2/28 mortgage in which the interest is currently fixed at around 9 percent for the first two years, then adjusts upward every six months thereafter. Lenders package these loans and sell mortgage-backed securities to investors who are willing to take on a high amount of risk for better returns.
As a result, lender loyalties have shifted to investors from borrowers.
“Fannie Mae, Freddie Mac (two of the largest housing loan wholesalers) were mostly doing conventional market loans to create mortgages,” said Adolfo Laurenti, senior economist at Mesirow Financial Holdings Inc. in Chicago. “Then new players stepped in with lower quality but high-yield mortgages.”
To make these securities more palatable to investors, brokers included terms like prepayment penalties, which discourage borrowers from refinancing into other loans, said UIC’s Ashton.
“They’re out there trying to hedge [their mortgage funds] and structure the instruments in such a way that they can insulate investors from those problems,” he said. “And they were wrong.”
The liquidity of mortgage markets had made everyone think they could afford to buy more than before.
“All that capital was flooding into urban housing markets, bidding up prices,” Ashton said. “When you multiply that across tens of thousands of borrowers, that suddenly means that more people are out there bidding up the price of homes.”
The miscalculations on lenders’ hedges exposed the problems in the housing market, as more people defaulted than even the large lenders had predicted.
“It’s often said that subprime lending has allowed people to achieve the American dream of home ownership,” van Zalingen said. “That’s really not true. Eighty percent of subprime loans were refinances of existing mortgages.”
As the housing market started to hit turbulence, the “speculative bubble” began to collapse, Ashton said. People started to default at a much higher rate and were making mortgage payments on homes that were worth less than what they had paid for them, he said. Wall Street became wary as the number of defaults increased. Big banks stopped lending as freely, further deepening the crisis for homeowners who tried to refinance their ARMs, and new buyers could no longer get loans.
Homeowner advocates and academics said foreclosures are caused by a combination of factors and aren’t limited to borrowers with poor credit. This is why a solution to the foreclosure crisis requires a holistic solution.
“Ultimately, I think the response has to also be in greater regulation,” UIC’s Ashton said. “Lenders shouldn’t be allowed to be making loans where the possibility [exists] that someone is going to be paying 50 percent of their income.”
Until there is a solution, however, homeowners will be the ones to suffer.