Defaulting on the Dream

QUICK SUMMARY

Few imaginable economic events send the same message of fear and foreboding in America as a housing crisis. For most Americans, their homes are their greatest asset. And for the states, industries dependent on housing are cornerstones for economic growth and fiscal stability.

Dear Reader:

Is the American Dream slipping away? One in 33 current U.S. homeowners may be headed toward foreclosure in the coming years because of subprime loans, according to our new report, Defaulting on the Dream. In some states, the crisis is particularly acute—in Arizona, for instance, one in every 18 homeowners could lose their home; in Nevada, the ratio is one in 11.

The problem hardly stops there. Because of foreclosures in their communities, an additional 40 million homeowners may see their property values and their municipalities' tax bases drop by as much as $356 billion in the next two years. Nearly every state is affected: in 47 states and Washington, D.C. the number of mortgage loans entering foreclosure as of December 2007 had increased by at least 20 percent since December 2006. Ten states alone could lose a total of $6.6 billion in tax revenue in 2008, according to a recent analysis by the firm Global Insight.

The stakes are incredibly high. Homeownership is the primary vehicle through which American families build financial security. It also is an essential building block of state and local economies.

Defaulting on the Dream: States Respond to America's Foreclosure Crisis is the first-ever comprehensive look at what states have been doing to tackle this critical issue. It showcases approaches in two principal areas: (1) helping borrowers avoid foreclosure and keep their homes; and (2) preventing problematic loans from being made in the first place. This report recognizes that while some states moved quickly to respond, their approaches are not yet proven.

At this writing, federal lawmakers are deliberating important proposals to try to address the crisis. Among other measures, Congress is considering federal funds to expand counseling programs for homeowners at risk of foreclosure, tax-exempt bonds for localities to refinance subprime loans and a hefty increase in federally insured mortgages. It also is debating the need to strengthen underwriting standards.

While policy makers and the media have focused on the immediate foreclosure crisis, Pew, together with our partners, continues to call for more action to strengthen standards to prevent more troubling loans from being made in the future. While the causes of the current crisis are multifaceted, had these basic consumer protection safeguards been in place, we may have curtailed this current calamity. The need is particularly acute as Congress considers ways to rewrite loans for those borrowers currently facing foreclosure. In this arena, many states have taken the lead, requiring lenders to verify a borrower's income and ability to repay at the fully indexed interest rate and not just at the low initial “teaser” rate, requiring the escrow of taxes and insurance payments and documenting the value of the property being financed.

Most experts agree this is a national crisis that warrants a national response, with the federal government providing both leadership and funding. But Congress should take into account what some states already have put in motion to try to stem the foreclosure tide and prevent the crisis from happening again. In the absence of federal leadership, states have been experimenting with homeowner counseling, refinance programs, stronger regulation of lending practices and other actions. As it deliberates, Congress should be aware of how its decisions will impact states' efforts already underway—building on, rather than pre-empting, the strongest state statutes, and ensuring that states retain the flexibility to respond to local conditions and needs.

Defaulting on the Dream was researched and written by The Pew Charitable Trusts' Center on the States (PCS), in collaboration with Pew's Health and Human Services (HHS) program. PCS identifies and encourages effective policy approaches to critical issues facing states. HHS' Family Financial Security portfolio seeks to advance common-sense solutions to help Americans save for tomorrow and manage debt today. The Center for Responsible Lending, one of the portfolio's partners and a key source of data and analysis for this publication, focuses on expanding homeownership by curbing abusive lending practices.

We hope this report informs Congress' important deliberations and helps ensure that federal and state policy makers work closely together to address America's foreclosure crisis.

Sincerely,

Sue Urahn
Managing Director
Pew Center on the States

Shelley Hearne
Managing Director
Health and Human Services

OVERVIEW

Few imaginable economic events send the same message of fear and foreboding in America as a housing crisis. For most Americans, their homes are their greatest asset. And for the states, industries dependent on housing are cornerstones for economic growth and fiscal stability.

Almost every state in the country has seen a significant increase in mortgage foreclosures, largely triggered by defaults on subprime mortgages. Yet greater challenges lay ahead. Based on new foreclosure projections by the Center for Responsible Lending, Pew estimates that one in 33 current U.S. homeowners will be in foreclosure, primarily in the next two years—the direct result of subprime loans made in 2005 and 2006. Among the states hardest hit are Nevada, where one in 11 homeowners could soon be in foreclosure; California, with one in 20; Florida, with one in 26, and Georgia, with one in 27.

In other states where the numbers are less severe, the situation is still troubling. If the economy tightens and home prices continue to fall, as many economists believe will be the case, more states and their residents will feel increasingly acute pain. The nation's foreclosure crisis does not discriminate by region or size. In states such as Colorado, Indiana, Maryland, Michigan, Ohio, Oregon, Rhode Island, Tennessee and Texas, at least one in 37 homeowners is projected to experience foreclosure as a result of a subprime loan.

Nationally, about 3.3 million home mortgages may default in 2007 and 2008, and more than two million homeowners could lose their homes, according to Mark Zandi, Moody's Economy.com's chief economist, who testified before the U.S. House Housing Financial Services Committee in February 2008.¹ 

The effects reach far beyond a single house on a single block. Homeowners are estimated to lose $356 billion in home value because of nearby foreclosures, affecting nearly 40 million homes. The foreclosure problem also has spread to homeowners with prime loans— borrowers with solid credit histories. With home prices falling and credit tightening, prime borrowers are facing the same financial stress as those with subprime credit.

While this is a national crisis, states and local municipalities arguably will be asked to carry a larger share of the foreclosure burden as tax revenues decline and they experience increased demands for police and other services to deal with vacant and abandoned
properties.

A growing number of states have taken action, seeking at least to mitigate the damage to homeowners, lenders, municipalities and their own budgets. The severity and speed of the crisis have meant that, in many cases, states are experimenting with innovative but as yet unproven approaches. The jury is still out about whether and to what extent they will be effective. Still, several states among those hardest hit by foreclosures also have been among the most assertive in trying to address the problem.

These states are using a range of approaches to help residents at imminent risk of foreclosure from losing their homes. They are beefing up lending enforcement to prevent problematic loans from being made in the first place. And recognizing that the crisis demands a collaborative approach, they are bringing together all the major stakeholders, including lenders and representatives of the financial services market, to try to tackle the challenges comprehensively.

Ohio, for instance, launched a statewide campaign, including a 24-hour hotline, to encourage borrowers at risk of foreclosure to seek counseling. Ohio also sought involvement across the state to improve assistance for borrowers facing foreclosure, calling on lenders in the state to modify high-cost loans for homeowners. In early April, Governor Ted Strickland reached agreement with nine mortgage servicers on a significant effort to modify the terms of adjustable-rate subprime mortgages in Ohio. These and other actions sprang from a task force, created in March 2007 by the governor, that convened representatives from industry, government and the nonprofit sector to collaborate on policy recommendations.

Michigan now has two loan funds that help homeowners facing foreclosure, a statewide consumer education campaign and a task force; the state also requires greater disclosure of terms and conditions before a high-risk loan is made. California, which launched a task force last year, regulates mortgage brokers and high-risk loans and has issued a notice to loan servicers calling on them to agree to wholesale loan adjustments.

Although they had fewer loans in the foreclosure process as of December 2007, states such as Maryland and Massachusetts are taking similar steps, recognizing that they will face bigger problems if they do not act. Maryland recently passed sweeping emergency reforms, providing immediate help to distressed homeowners while strengthening the state's oversight of the mortgage industry. It extended the foreclosure process from 15 to 150 days, criminalized mortgage fraud, banned prepayment penalties and is seeking to prevent deceptive foreclosure rescue transactions. Massachusetts soon will provide borrowers in default on their mortgage payments 90 days to work with their mortgage servicers to try to avoid foreclosure. In addition, the state recently made $2 million in grants available for foreclosure education, prevention and counseling initiatives.

Some states are contemplating more aggressive actions to delay foreclosure and its ripple effects on neighboring homes. In New York, legislators proposed a moratorium on foreclosures for one full year. Massachusetts, Minnesota and New Jersey have proposed six-month deferments of foreclosures, with Minnesota and New Jersey's proposals including some form of rent-back or partial payment from the delinquent borrower. These proposals to place longterm moratoria on foreclosures face steep industry opposition, but they highlight the pressure states are under to try to address the current crisis.

But given the scale of the crisis and the complexity of today's mortgage markets, states cannot go it alone, and it makes little sense to have 50 separate and specific responses. There is broad agreement that the federal government should take a strong leadership
role. As it considers a range of proposals, both to help more homeowners stave off foreclosure and to strengthen underwriting standards, Congress should understand what states already are doing and how its policy choices will affect those efforts. It also should ensure that states have flexibility to pursue measures that respond to their particular circumstances and needs and build on, rather than pre-empt, those actions that go the furthest in protecting homeowners from practices that undermine wise and responsible borrowing choices.

We have based our findings in this report on data and analysis that are comparable to information from well respected industry analysts such as First American, Lehman Brothers, Merrill Lynch, Credit Suisse and Moody's Economy.com. We rely on the Mortgage Bankers Association's National Delinquency Survey to highlight foreclosure challenges at the end of December 2007. In addition, we use the Center for Responsible Lending's projections to draw attention to the estimated number of foreclosures and ripple effects from subprime loans made in 2005 and 2006. However, as any researcher will note, these data have limitations; for a more detailed description of our methodology, see page 6.²

We have used the best available data to describe the challenges that our nation and states may face. But the current policy debate has been limited by the lack of data on the actual number of loans that have ended in foreclosure. Policy makers need accurate, comprehensive and up-to-date information to fully understand their foreclosure problems and identify potential solutions. States have an important role to play here, and many are already building systems that link property descriptions, mortgage information and foreclosure actions. However, having 50 idiosyncratic foreclosure databases is not a solution. Instead, Congress and the states should consider ways to collect, maintain and share reliable and uniform information across all 50 states to more accurately describe current conditions and better assess the effectiveness of policy interventions.

SUMMARY

Summary: Key Facts about the Foreclosure Crisis

The media have dubbed the current situation a “subprime mortgage crisis.” But the current foreclosure data and forthcoming trends show a more complex story, one in which a growing number of homeowners and prime loans are threatened. In short, nearly every homeowner and prospective homeowner is somehow affected by this crisis.

• Pew's analysis estimates that one in 33 current U.S. homeowners nationwide is projected to face foreclosure, primarily in the next two years, as a result of a subprime loan made in 2005 and 2006.³
• Pew's analysis of recent mortgage delinquency data found that subprime loans—high-risk loans to people who do not qualify for a prime or conventional loan because of low income or poor credit—make up just 14 percent of all mortgage loans being serviced, but more than half of all loans in foreclosure.⁴
• Nearly every state is affected: in 47 states and Washington, D.C. the number of mortgage loans entering foreclosure as of December 2007 had increased by at least 20 percent since December 2006.⁵
• Pew's analysis found that projected subprime foreclosure challenges are spread across states more evenly, indicating that the foreclosure crisis is nationwide and not merely concentrated in a few states.⁶ 
• 10 states alone will lose a total of $6.6 billion in tax revenue in 2008 as a result of the foreclosure crisis, according to a 2007 projection.⁷
• 1.6 million loans were in foreclosure or 90 days past due as of December 2007—up 55 percent from a year earlier.⁸
• More than 40.6 million homes across America are projected to lose value because of subprime foreclosures in their communities. Foreclosures may cost neighboring properties up to $356 billion in home value over the next couple of years.⁹
• U.S. foreclosure starts, as of December 2007, involving prime adjustable-rate mortgages increased 158 percent in one year.¹⁰ 
• Homes in foreclosure usually sell far below market value, especially in today's depressed real estate market, and unsold properties can be expensive to maintain. Lenders experienceforeclosure losses ranging from 20 cents to 60 cents on the dollar, with one estimate of a typical lender's foreclosure cost averaging $58,800 in the early 2000s.¹¹

Summary: How States Have Responded to the Crisis

The foreclosure crisis facing America is a national challenge, and it requires a national response. The federal government must provide leadership and funding to address it. Among other measures, Congress at this writing is considering proposals that would provide federal funds to expand counseling programs for homeowners at risk of foreclosure, tax-exempt bonds for localities to refinance subprime loans and a hefty increase in federally insured mortgages. Congress also is contemplating strengthening underwriting standards.

Pew's research found that states also have a critical role to play—and today, a growing number of state policy makers are taking action in three major ways: trying to help borrowers facing imminent risk of foreclosure to stay in their homes; preventing high-risk, high-cost mortgage loans from being made in the first place; and taking a comprehensive approach to the crisis by convening stakeholders to develop solutions.

HELPING CONSUMERS AVOID FORECLOSURE AND STAY IN THEIR HOMES

• Nine states have publicly supported mortgage refinance funds and have committed at least $450 million in loan funds to help borrowers avoid foreclosure.¹²
• California, Massachusetts and Ohio are encouraging lenders to modify defaulted loans to help homeowners keep their homes.
• Nine states have implemented regulations that prevent foreclosure rescue scams.
• 20 states have partnered with the Homeownership Preservation Foundation to provide around-the clock consumer counseling hotlines.
• States such as Indiana, Maryland, Massachusetts and Ohio have led media campaigns to educate at-risk borrowers about how to seek help.
• California, Indiana and Minnesota mandate that lenders give borrowers in danger of defaulting early notice about available assistance.

REDUCING THE NUMBER OF HIGH-RISK LOANS BEING MADE

• 31 states regulate high-cost loan products.
• 24 states require or recommend consumer education and counseling.
• Nine states require mortgage brokers to consider or represent the interests of the borrower when recommending mortgages.

CONVENING STAKEHOLDERS TO DEVELOP COMPREHENSIVE SOLUTIONS

• 14 states have created foreclosure task forces to try to address the challenges of the crisis comprehensively, including bringing government leaders, lenders, advocates and experts to the table to work on solutions.