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Subprime Foreclosures Burst the Housing Bubble

Posted: 26-12-2008 | Views: 207

The first sign of trouble for the housing market was the implosion of subprime in early 2007. Subprime borrowers stopped paying back the loans they were given due to loan resets and payment recasts. These defaults lead to foreclosures. During the bust, the vast majority of properties at auction went back to the lenders because the loan amounts usually exceeded market value. Properties purchased by the lender at a foreclosure auction are called Real Estate Owned or REO.

There is a sequence of events which occurs between the mortgage reset and the final sale of a property to a new owner on the open market. After the borrower is faced with a mortgage reset, many try to make the new payment and keep their houses. They may borrow from other sources including credit cards or even their retirement accounts, anything to make the payment and keep their homes. Depending on the resources available and the burden imposed by the new payment, the borrower may stay afloat for an indefinite period of time. Some chose to give up immediately and 30 days later, they are in default.

Once a borrower defaults on a loan, in most states the lender is required to wait 90 days to give the borrower a chance to get current on their payments. Once a borrower is 90 days late, he receives a Notice of Default from the lender. Following the Notice of Default, there is another 90 day window where the borrower can make good on their payments. If he is unable (or unwilling) to do so, the lender will file a Notice of Trustee Sale and schedule a public auction for 21 days later. If the borrower cannot pay back the loan or find other ways to delay the process, the property is put up for public auction, generally on the courthouse steps in the jurisdiction where the property is located. At this auction, the lender will generally bid the amount of the outstanding loan and hope another party bids more and pays them off. If the lender is the highest bidder, which is often the case, the lender ends up owning the house.

Lenders are not permitted to keep REOs on their books for long, so these properties are offered at market prices, and they must be sold. It will take some time for the property to be prepared for sale. Once the property is finally listed for sale in the conventional resale market, the lender will follow loss mitigation procedures intended to maximize revenue from the property. This often delays the eventual sale 90 days or more. The whole process from mortgage reset to final sale in the market takes at least a year, and it may take much longer.

The subprime borrowers made up the bulk of the mortgage rate resets in 2007 and 2008. Since the default rates were very high, and since prices were already falling before these REOs were added to the market, the subprime foreclosures pushed prices down significantly. This effect was not uniform as subprime borrowers were often concentrated in specific areas or communities. Markets with large concentrations of subprime were decimated first, but all markets are interrelated, as all real estate markets within driving distance are linked together by commuters.

When the subprime-dominated markets declined, they created a drag on prices and sales volumes in nearby markets. There was a price differential that enticed people to fringe markets. This created a price drag on the primary markets as some potential buyers were siphoned off by the fringe markets. In California, the collapse of the real estate market was like a land tsunami: it started inland and made it way overland to the coast leveling everything in its path.

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