Loan Performance and Negative Home Equity in the Nonprime Mortgage Market

GAO-10-146R: Published: Dec 16, 2009. Publicly Released: Jan 13, 2010.

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As GAO reported to Congress in July 2009, the number of nonprime mortgage originations (including subprime and Alt-A loans) grew rapidly from 2000 through 2006, a period during which average house prices appreciated dramatically. In dollar terms, the nonprime share of mortgage originations rose from about 12 percent ($125 billion) in 2000 to approximately 34 percent ($1 trillion) in 2006. These mortgages have been associated with what was subsequently recognized as a speculative housing bubble. As house prices subsequently fell, the subprime and Alt-A market segments contracted sharply, and very few nonprime originations were made after mid-2007. Borrowers who had obtained nonprime mortgages earlier in the decade increasingly fell behind on their mortgage payments, helping to push default and foreclosure rates to historical highs. Economic conditions and a weak housing market have contributed to the increase in troubled loans. In particular, falling house prices have left many borrowers in a negative equity position--that is, their mortgage balances exceed the current value of their homes. Negative equity makes borrowers more vulnerable to foreclosure by, among other factors, limiting their ability to sell or refinance their homes in the event they cannot stay current on their mortgage payments. To inform congressional decision making about efforts to address problems in the mortgage market, Congress requested that GAO examine the evolution and condition of the market for nonprime loans. On July 28, 2009, GAO provided Congress with an interim report on certain characteristics of nonprime loans and borrowers, and the performance of nonprime mortgages originated from 2000 through 2007 (the last year in which substantial numbers of nonprime mortgages were made) as of March 31, 2009. This report (1) provides information on the performance of these nonprime loans as of June 30, 2009, and describes forecasts made by others of future loan performance; and (2) examines the extent of negative home equity among nonprime borrowers in selected metropolitan areas and nationwide. In addition, this report describes the preliminary results of GAO's analysis of the demographic characteristics of nonprime borrowers--including race and ethnicity--whose loans originated in 2005. GAO identified these characteristics by merging loan-level records from two data sources. This report also provides supplemental information on the performance of nonprime mortgages by annual loan cohort, product type, Census division, state, and congressional district.

The performance of mortgages in the nonprime market segment worsened during the second quarter of 2009 (April 1 through June 30, 2009), as the number of loans that completed the foreclosure process or became seriously delinquent increased from the previous quarter. For example, 147,000 loans completed the foreclosure process in the second quarter, an increase of 9 percent from the first quarter, and the number of seriously delinquent loans grew by about 48,000, a 4 percent increase. The growth in serious delinquencies, coupled with a decline in the total number of active loans due to prepayments and completed foreclosures, increased the serious delinquency rate from 23 percent to 26 percent during the second quarter. Although serious delinquencies were most prevalent among subprime borrowers and for adjustable-rate products, serious delinquencies in the second quarter of 2009 were growing most rapidly for Alt-A borrowers and fixed-rate mortgages. The number of nonprime loans that were seriously delinquent rose by approximately 2 percent (16,000) in the subprime market, compared with 7 percent (32,000) in the Alt-A market. For fixed-rate Alt-A loans, the corresponding increase was 11 percent (13,000). Forecasts made by others suggest that weaknesses in the nonprime mortgage market will persist, primarily due to expected declines in home prices. GAO's analysis of borrowers with active nonprime mortgages originated from 2000 through 2007 indicates that a substantial proportion had negative equity in their homes as of June 30, 2009. GAO's estimates using the S&P/Case-Shiller index for 16 metropolitan areas showed that the percentage of borrowers with negative equity ranged from about 9 percent (Denver, Colorado) to more than 90 percent (Las Vegas, Nevada). GAO's estimates also indicate that in the 16 metropolitan areas it reviewed, nonprime borrowers who obtained their mortgages to purchase a home were more likely to have negative home equity than those who refinanced their mortgages. Using the Federal Housing Finance Agency (FHFA) index, GAO estimated that one-quarter of nonprime borrowers with active loans nationwide had negative equity in their homes as of June 30, 2009. GAO also found that the incidence of negative equity was highest among borrowers who obtained their mortgages in 2005, 2006, and 2007.

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