Adjustable-Rate Mortgages Fuel Foreclosure Crisis

New foreclosure filings hit an all-time high this spring. And that was before the latest turmoil in the mortgage market.

Defaults are heavily concentrated in seven states, according to the Mortgage Bankers Association. Three of those — Michigan, Indiana and Ohio — have been hit with heavy job losses. But the other four — California, Arizona, Nevada and Florida — have a different problem.

"What's going on in these four states is, first of all, they tend to have very high levels of adjustable-rate mortgages," says Doug Duncan, chief economist for the association.

When those mortgages adjust upward, some people are unable to make the payments, and the problem is likely to continue for at least another year.

Two weeks ago, a San Diego nonprofit group called Community HousingWorks had a workshop for homeowners facing trouble with their mortgages. Seventy families showed up.

"If we tried to do that last year, we might have three or four families," says Gabe del Rio, vice president of lending and homeownership with Community HousingWorks. "So, what it says is, the communities around here are in major distress and really crying out for help."

On del Rio's desk is the file for one family whose monthly payment has just gone from $2,900 to $4,200.

"That's somebody who we would try ... because they were current before the adjustment, to go back to that original rate, and fix it at that for the rest of the term," del Rio says.

Some lenders will agree to a lower, fixed-rate payment if the alternative is no payment and foreclosure. Earlier this week, federal regulators issued new guidelines encouraging lenders to consider that kind of assistance.

If lenders won't budge, though, borrowers may need help refinancing into a new mortgage, especially if they owe more than their home is worth.

"In those cases," says del Rio, "coming in with a new first mortgage that's stable, that the borrower and the homeowner can afford, that's going to help a lot of people."

Mortgage insurance from the Federal Housing Administration would make that kind of refinancing easier. But the FHA can only guarantee mortgages up to $362,790. That excludes a lot of homes in high-cost markets like San Diego. So Congress will consider raising the limit.

Fannie Mae and Freddie Mac might also be able to provide money for refinancing. Democratic Senator Charles Schumer of New York says it would help if the government-sponsored agencies were allowed to hold more mortgages on their books, something the Bush administration has been reluctant to permit.

"A good compromise," Schumer says, "would allow them to lift the portfolio caps — but only for specific loans that would go to homeowners about to go into foreclosure."

Schumer also wants more money to pay for counseling distressed homeowners. Community HousingWorks' del Rio says that would be helpful. But he cautions that no amount of counseling will keep some people in their homes.

For example, there are families who are hundreds of dollars behind on their mortgages each month, even before their adjustable rates go up.

"Generally, those people have fallen prey to a pushy, overbearing loan originator who wanted to close a loan," del Rio says. "These families get caught up in the dream and thinking equity's going to increase and they can always sell."

Del Rio says families like that — maybe one-third of those who contact his agency — are better off walking away from their homes and moving back to rental properties they can afford.

"It's really tough as a counselor to have to tell the real truth to everyone. And sometimes that's tough love that we have to provide," he says.

The nation's housing market is likely to get more of that tough love this year and next as nearly 2 million adjustable mortgages reset.