Foreclosures tied to unscrupulous mortgage deals

El Paso County’s mounting foreclosure problem has its roots in the national meltdown of mortgages: unscrupulous lenders making loans to borrowers with shaky credit history using loans that had little chance but to go bad.

In many cases, local homeowners facing foreclosure have subprime loans — loans made with loose credit requirements and such exotic-sounding features as interest-only payments and negative amortization, a Gazette analysis of mortgage data shows.

The surge of foreclosures stems from efforts to stretch lending standards for borrowers. The loans often were made to borrowers with no down payment, bad credit or low incomes.

What borrowers got were mortgages they didn’t understand that would later doom them to default and lose their homes, experts say.

Subprime mortgages typically are marketed with a low promotional rate that allows the borrower to qualify for the loan. That rate usually expires after two years and increases by as much as five percentage points, increasing the monthly payment by up to 40 percent.

Without the promotional rates, subprime mortgages average about 2 percent higher than rates on prime loans to compensate for a higher risk of default. Such loans almost always have rates that go up and down with other interest rates and include penalty charges to keep buyers from refinancing into another mortgage.

Subprime loans have made up about 13 percent of the new mortgages in El Paso County since 2005. But they made up nearly half of all the local loans in foreclosure in March, according to First American LoanPerformance, which maintains the nation’s largest home mortgage database.

The San Francisco-based company’s database of more than 100 million mortgages includes half of all subprime loans, and 85 percent of all prime loans, which go to borrowers with good credit.

Among all local mortgages in foreclosure in March, almost half — 47 percent — were subprime loans, LoanPerformance said. That figure mirrors state and national statistics on subprime mortgages.

In El Paso County, subprime mortgages have ended up in foreclosure at more than 15 times the rate of loans to borrowers with good credit. Nearly 4 percent of subprime mortgages in the county were in foreclosure in February, compared with just 0.25 percent of loans to prime borrowers, according to LoanPerformance.

“What happened is that we allowed people who had made little mistakes with their credit to make much larger mistakes with a mortgage,” said Wayne Bland, a board member of the Colorado Mortgage Lenders Association and vice president of Rocky Mountain Bank & Trust.

Early in the decade, mortgage bankers began aggressively marketing subprime mortgages as a way to get people into homes — and as a way for investors who fund mortgages to get higher returns.

Investor “appetite for risk kept increasing,” said Bland, a longtime local mortgage banker. “They thought they could mitigate risk by charging a higher rate, but they guessed wrong about how many would go into default.”

Bankers — including some of the nation’s biggest lenders as well as companies that specialized in subprime mortgages — created an alphabet soup of mortgage options. Many included features that increase the risk such loans will end up in foreclosure, including interest rates that are adjusted, often to a higher rate, after the first two years.

Subprime loans grew in popularity because such mortgages often allowed borrowers to buy a house without a down payment and included promotional rates that temporarily cut a homeowner’s monthly payment.

Many subprime loans made locally were marketed primarily to low- to moderate-income homeowners as a way to reduce their monthly payment by refinancing the mortgages they already had. Other borrowers used subprime loans to buy their first homes.

At the same time, lenders loosened their borrowing requirements for these subprime loans.

And in many cases, borrowers may not have understood all the terms and conditions of the loans, experts say.

“We took loan counseling out of the equation and borrowers were shopping for mortgages just like they do for car loans — by the monthly payment,” said Robert “Hutch” Hutchinson, a longtime local mortgage banker and president of Colorado Springs-based Colorado Online Mortgage.

“There are mortgage products out there that can be a financial trap if the borrower doesn’t understand what they are getting into,” Hutchinson said.

In El Paso County and statewide, more than 80 percent of all subprime loans in foreclosure were adjustable rate mortgages, according to LoanPerformance. By contrast, nearly 80 percent of prime mortgages locally and nationwide carried a fixed interest rate.

The rates on subprime adjustable rate loans typically go up after two years, and that’s when most borrowers ended up in foreclosure, according to the Gazette analysis of foreclosure data.

The median period, or midpoint, between mortgage origination and foreclosure for county loans that went into foreclosure from 2002-2006 was less than 2½ years, a period that declined during all but one of the five years in the analysis.

An analysis of mortgage foreclosures filed from 2001-mid-2006 by the Southern Colorado Economic Forum found that rates on foreclosed loans in the county averaged 1.6 percent above the market rate at the time, said Fred Crowley, the forum’s senior economist.

Subprime borrowers “were very clearly put into loans they couldn’t afford by the time they ended up in foreclosure,” Crowley said. “They were convinced to get into a mortgage they couldn’t afford, and couldn’t get out of later because they would have owed a penalty to refinance.”

Most subprime loans were intended to be a bridge to traditional mortgages once the borrower demonstrated a solid payment history, said Victor Pelster, owner of Springs-based Anchor Mortgage Inc., which makes subprime and traditional loans.

“The plan was that the borrower would eventually be able to refinance into a fixed-rate prime mortgage,” Pelster said. “Those in foreclosure probably weren’t able to refinance because their circumstances didn’t improve enough” to qualify from a prime loan.

The subprime market began to sour last year as home values leveled off in many areas, leaving many subprime borrowers owing as much or more than the property was worth. That left borrowers unable to refinance the loan or sell the home once payments started rising.

The subprime lending industry’s problems were compounded by a weakening housing market that made it more difficult for borrowers with delinquent loans to sell their homes, said Pat Libbey, owner of CitiLine Mortgage Co., which makes subprime and prime mortgages.

“Once the market started cooling off, the weaknesses of these borrowers started to be exposed,” Libbey said. “When you have a 100 percent loan, you have no vested interest if you can’t afford to make the payments. That’s especially true if you haven’t built any equity because the market is declining.”

As subprime mortgage defaults and foreclosures soared, the Wall Street investment banks that bought the loans stopped funding new mortgages and enforced agreements that required lenders to buy back bad loans. Awash in bad loans without new funds, dozens of subprime lenders filed for bankruptcy or were shut down by their corporate parents.

The subprime industry’s collapse prompted lenders to raise credit standards, including requiring better credit and at least some down payment.

Subprime mortgage problems continue to grow, locally, statewide and nationally. The percentage of subprime mortgages in the county that are in foreclosure or more than 60 days delinquent have both been climbing during the past year, according to LoanPerformance.

A December study by the Durham, N.C.-based Center for Responsible Lending forecasts that 11.4 percent of the subprime loans made in the Springs between 1998 and 2001 will eventually end in foreclosure and 18.4 percent made last year will go into foreclosure.

Nearly half of all subprime loans nationwide are expected to be delinquent at least once within five years. More than 20 percent,or 2.2 million, will end up in foreclosure, the study said. The risk of foreclosure rises if the borrower refinances with another subprime loan.

Much of the blame for the subprime lending crisis belongs to mortgage brokers who put borrowers “into loans that were not in the best interest of the client,” said Kevin Guttman, a former subprime broker who now owns Springs-based My Mortgage Co.

“Does the borrower have the ability to repay this loan, or is it just a transaction to me and I know I’m going to get paid” whether or not the loan defaults, Guttman said.

The surge in foreclosures captured the attention of legislators and newly elected Gov. Bill Ritter in the session that ended in May. On June 1, Ritter signed into law June 1 a series of bills designed to protect borrowers and slow the growth in mortgage foreclosures by:

-- Expanding state regulation of mortgage lenders and prohibiting them from engaging in misrepresentation, fraud and conflicts of interest.

-- Increasing penalties for deceptive mortgage advertising and requiring lenders to find loans that take borrowers’ financial situation into consideration.

-- Requiring lenders to act with “good faith and fair dealing” and making failure to do so a violation of the state’s consumer laws.

CONTACT THE WRITER: 636-0234 or wayneh@gazette.com