A “self reinforcing downward cycle”

From the International Herald Tribune:

The dream of home ownership, now a nightmare

Three years ago, Martin and Jennifer Cossette bought into the dream of homeownership, the quintessentially American ideal of personal striving and family stability celebrated by politicians, promoted by Madison Avenue and financed by Wall Street.

The modest Cape Cod-style house, in Meriden, Connecticut, had three bedrooms and a backyard for their young son, Steven. Like so many families, they stretched to buy their first home. In the red-hot housing market at the time, they put no money down and got a mortgage for its entire $180,000 price.

They had qualms but too few, as reassuring lenders spoke of rising housing prices, falling interest rates and easy access to future loans.

None of it turned out that way. There were unforeseen expenses: a new furnace, stove and garage door. Bills mounted and credit card debt got out of hand. They refinanced in late 2005, folding other debts into the mortgage, but that proved to be only a stopgap.

Earlier this year, the Cossettes filed for bankruptcy under Chapter 13, used by wage earners who want to hold onto their homes. But the monthly payments on the $230,000 mortgage were $1,800, 40 percent higher than the first mortgage, and headed even higher. So they decided to let the house go.

“We were totally naive,” said Cossette, a purchasing agent for a warehouse company.
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Looking at foreclosure warning signs like loan delinquency and default rates, which are spiking, Mark Zandi, chief economist of Economy.com, said the outlook was “very dark,” largely because of the current “self-reinforcing downward cycle” of falling house prices, loan defaults and credit tightening that pushes house prices down further.

There are regional and local differences, to be sure. Problems tend to be more pronounced in a few Midwestern states with weak economies, like Michigan and Ohio, and states with the greatest concentration of subprime loans, like California, Florida and Nevada. “But the trouble is not just a few places. It’s coast to coast now,” Zandi said.
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For people struggling to hold onto their homes, the path to financial peril usually began with bad loans. Bad choices often made matters worse.

That is the story Neil Crane hears and sees every day in Connecticut, a state that closely tracks the national trends in mortgage loan delinquencies and defaults. Crane, a lawyer in Hamden, Connecticut, has been handling personal bankruptcies for 25 years. Business is brisk. His office takes on 30 new cases a month, a 50 percent increase in the last year and a half.

His clients, including the Cossettes, are families typically with household incomes of $65,000 to $90,000 a year. In the past, Crane said, it was usually the loss of a job, a lengthy illness or another unexpected setback that pushed people into bankruptcy.

“But what we see now are people who refinanced to pay existing bills, with the encouragement of lenders, on very poor terms that only worsened their problems,” he said. “If you sat in at the mortgage closing, you could have predicted the bankruptcy.”

Joseph and Lu-Ann Horn bought their 1,200-square-foot, or 111-square-meter, three-bedroom home in South Windsor, Connecticut, in 2002, paying for nearly all of it with a $150,000 loan. The mortgage was a 30-year loan with a fixed rate of 7.5 percent. Two years later, they decided to refinance to pay off their truck and their credit card debt and to buy a $4,000 motorcycle.

The new mortgage was for $198,000, at a fixed rate of about 8 percent for two years and variable rates afterward. The monthly payment was about $1,600. The mortgage broker, Joseph Horn said, told them not to worry about the variable rate because they could refinance in two years and lock in a fixed rate again.

“They basically put us in a loan that they knew we couldn’t pay,” Horn said. “We never should have done it.”

When the fixed rate expired last year, the Horns found no willing lenders. The interest rate has jumped and the monthly payments rose to nearly $2,200, Lu-Ann Horn said. “It just goes up and up,” she said.

Jospeh Horn, 34, is a truck driver, and Lu-Ann Horn, 39, is an assistant manager in a fast-food restaurant. They make about $70,000 a year, but with two children and other expenses they fell behind on the mortgage. They have been served with foreclosure papers, and have filed for Chapter 13. “We’re fighting to hold onto the house now,” Lu-Ann Horn said.
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For Sue Ellis, 47, a nurse in Northford, Connecticut, the road to bankruptcy began with a home improvement project six years ago. “If I had it to do over again, I never would have redone my kitchen,” she said.

The first refinancing added $40,000 to her original mortgage of $140,000 on the small ranch house she bought in 1997. She was a single parent and wanted to have a backyard for her two children. The monthly payment on the original mortgage was about $850.

Ellis has since remarried, and she and her husband, Robert, a salesman at an industrial equipment company, make about $85,000 a year. But the higher mortgage and other bills led to two more refinancings, in 2003 and 2005, each to pay off about $40,000 in credit card debt. “We were using credit cards to pay the bills and then we refinanced to pay off the credit cards,” she said. “It’s a vicious cycle.”

Today, her mortgage debt is $260,000, and her monthly payments are $2,400. The value of her house, said Crane, her lawyer, is about $200,000. Ellis is a month behind in her mortgage payment and is not in foreclosure yet. But she has also accumulated more than $20,000 in credit card debt, and she is filing for Chapter 13 bankruptcy.