“The first wave of Americans to default on their home mortgages appears to be cresting,” writes Vikas Bajaj in this morning’s New York Times, “but a second, far larger one is quickly building.”

Homeowners with good credit are falling behind on their payments in growing numbers, even as the problems with mortgages made to people with weak, or subprime, credit are showing their first, tentative signs of leveling off after two years of spiraling defaults.

The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A mortgages, quadrupled to 12 percent in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7 percent in that time.

What’s especially interesting is how closely the scenario outlined in the Times article matches up with this chart, published last year by the International Monetary fund using data from Credit Suisse, showing the value of mortgage rate resets due to happen each month between 2007 and 2015. (A reset is when the repayment terms of a loan change—invariably by increasing—according to a schedule determined by the loan contract.)

Earlier this decade, as the ballooning housing market pushed the affordability index past the point where the average first-time homebuyer could afford a typical home in many areas, the real-estate industry kept the boom going by offering “teaser-rate” mortgages. These loans had artificially low annual percentage rates that were only good for the first few years of the contract, after which they would reset to a much higher APRs that the buyers in many cases would not be able to afford. As long as housing prices kept going up, the story went, buyers would be able to use the increased equity in their homes to refinance into more affordable loans. Then housing prices stopped going up.

As the IMF graph shows, the problem began a couple of years ago with a huge wave of resets in the subprime market, giving rise to talk about the so-called “subprime crisis.” It has been the failure of these loans that has been responsible for much of the turmoil in the housing market over the past couple of years. By early 2009, however, most of the subprime resets will be over and done with. Then, beginning in early 2010 and continuing for a couple of years, there will be another big wave of resets, this time in alt-A and option ARMs.

As this scarily prophetic Business Week article from nearly two years ago puts it, option adjustable rate mortgages — the so-called “pick-a-payment” mortgages — “might be the riskiest and most complicated home loan product ever created.” Option ARMs offer several payment choices each month, typically differing by thousands of dollars. The least expensive option doesn’t even cover the full amount of the interest due on the loan, so the leftover interest gets added to the principle (a situation called negative amortization). Option ARMs sold like hotcakes during the boom, accounting for 9 percent of the volume of all mortgages sold in the US in 2006, and significantly more in boom states like California and Florida.
According to Standard & Poor’s, more than 75 percent of option ARM holders were making only the minimum monthly payment in 2007.

Those attractive payment options come to an end when the mortgage resets. Faced with a monthly payment that’s nearly double what they’ve been making, a debt that’s tens of thousands of dollars bigger than it was when they took it out, and a home that may be worth less than their outstanding debt by a wide margin, many homeowners will be forced to default or to seek protection in bankruptcy court.

Option ARMs, it can’t be pointed out often enough, are prime loans, not subprime. As today’s Times article notes, prime and alt-A loans make up a much bigger percentage of most banks’ mortgage portfolios than subprime loans do, raising the specter of a new wave of defaults that may dwarf the troubles we’ve already seen:

“Subprime was the tip of the iceberg,” said Thomas H. Atteberry, president of First Pacific Advisors, a investment firm in Los Angeles that trades mortgage securities. “Prime will be far bigger in its impact.”

A few more highlights from the package of articles and features on the debt crisis from Sunday’s New York Times, which I first wrote about on Monday.

“Borrowers and Bankers: A Great Divide” is an analysis of the differences in how the federal government has responded to the financial woes of lenders and investors like Bear Stearns, Fannie Mae, and Freddie Mac (bailouts) vs. those of ordinary borrowers (you’re on your own), and explains some of the reasons behind the discrepancy.

“Work Out Problems with Lenders? Try to Find Them” talks about something I’ve written about in the past: mortgages are sliced and diced into securities and traded among big investors so much that people who want to work out payment terms with their lender are having difficulty even figuring out who they should be contacting. (I would be remiss if I did not point out that a good bankruptcy attorney can help you with this!)

In fact, as Sunday’s front-pager notes, it’s not just mortgage lenders who have been securitizing and trading consumer debt in recent years: credit card issuers have gotten into the act as well. The result has been the creation of a system in which lenders increasingly don’t even care if borrowers will ever be able to pay their debts in full. Securitization allows lenders to see an immediate return on investment (ROI) for issued debt instead of waiting years for the borrowers to pay it off, but it also means that they’re far less concerned with ensuring that borrowers can pay their debts off in full over the long run—as long as borrowers remain current until the lender unloads their promissory note onto someone else, the theory goes, all is well.

The lending industry has become a huge, nationwide game of Hot Potato, which worked well enough in good economic times, but as the economy has faltered we’ve started to see some of the huge problems that exist with a lot of these loans, and the so-called subprime mortgage crisis is looking more and more like it’s just the tip of the proverbial iceberg.

This is the second in a series of weekly posts examining the positions of the major presidential candidates on bankruptcy, debt, and personal finance issues. Last week’s post, in cased you missed it, dealt with individual bankruptcy. This week, it’s time to look at where the candidates stand on mortgage and foreclosure issues.

Barack Obama on the Mortgage Crisis (Issues Page)

Sen. Obama’s mortgage plan focuses on increasing the transparency of the lending business and giving borrowers more options for relief from onerous loans.

Sen. Obama proposes to make it easier for borrowers to obtain and understand information about the mortgage products available to them, creating “a simplified, standardized borrower metric (similar to APR)” for home mortgages. A 10 percent universal mortgage credit would apply to homeowners who don’t itemize their deductions; Obama says this would equal an average of $500 a year for 10 million homeowners. Obama would also create a fund to help homeowners escape foreclosure through refinancing, funded in part by penalties on fraudulent lenders.

Obama was an early critic of mortgage fraud and abusive lending practices. With Sen. Richard Durbin (D-Ill.), he sponsored the Stopping Transactions which Operate to Promote Fraud, Risk, and Underdevelopment (STOP FRAUD) Act, which would criminalize mortgage fraud on the federal level and increase funding to federal and state law enforcement to fight it. The STOP FRAUD Act is currently in committee and has not become law. He also proposes allowing bankruptcy courts to modify the mortgage payment of an individual in bankruptcy; Obama calls the current bankruptcy law “outdated” and says that it shields the subprime mortgage industry from the consequences of its “dangerous and sometimes unscrupulous” business practices.

John McCain on the Mortgage Crisis (Issues Page)

Sen. McCain’s main mortgage-related plank calls for a “HOME Plan” that would help distressed homeowners trade in an unmanageable mortgage for a less expensive one with payments they can afford. McCain’s plan would have more restrictive terms than Obama’s: eligibility is limited to “[h]olders of a non-conventional mortgage taken after 2005 who live in their home (primary residence only); can prove creditworthiness at the time of the original loan; are either delinquent, in arrears on payments, facing a reset or otherwise demonstrate that they will be unable to continue to meet their mortgage obligations; and can meet the terms of a new 30-year fixed-rate mortgage on the existing home.” The part about proving creditworthiness is a bit troubling: What happens to people who were duped by predatory lenders into taking on mortgages they couldn’t afford? It’s not clear. McCain’s plan also involves lenders voluntarily agreeing to write down delinquent mortgages to the current market value of the home, which lenders have not historically shown a great willingness to do.

On the law & justice front, McCain has called for the Justice Department to form a Mortgage Abuse Task Force to investigate potential criminal wrongdoing in the mortgage industry and prosecute any offenders. The task force would also offer assistance to state attorneys general as they investigate and prosecute mortgage abuse cases on the local level.

For more on the candidates’ proposals and differences on mortgage-related issues, watch this video report from the Associated Press:

Coming next week: The Candidates on Credit Card Issues

Sad news today that legendary Seattle jazz musician Ernestine Anderson, 79, is facing foreclosure on the Central District home that she and her family have owned and lived in since 1946. The Associated Press reports that Anderson, who has largely retired from performing and lives on Social Security benefits of about $1,000 a month, has a loan on her home that asks for a payment of $5,000 every month. Counselors are trying to find out more about how Anderson got into the loan, but given the size of the monthly payment it certainly sounds predatory. (Elderly people with lots of home equity but low incomes are prime targets for predatory lenders and scammers.)

Anderson has to come up with $44,000 in back payments and taxes by Monday, June 30, or her home will be put up for auction. Donations can be made at any Bank of America branch.

Following up on yesterday’s post about lenders being unable to produce the mortgage note in a shockingly high percentage of foreclosure cases, here’s a short video from the Consumer Warning Network about how you can make your lender prove in court that it has the right to foreclose on you in the first place.

It’s imporant to understand that challenging your lender on the note isn’t a “get out of debt free” card. What it can do is give you more leverage to bargain with an institution that may be treating you unfairly, and establish the true ownership of the loan so another party doesn’t try to collect the same debt from you in the future. Your creditors are trying to take your home to compel you to uphold your end of the mortgage contract. You have the right to insist that they uphold theirs.

This CNN story from earlier today highlights something I’ve been seeing recently in my practice: in many foreclosure cases, the lender can’t even produce the mortgage note—in other words, they can’t prove they’re the holder of the debt.

During the credit bubble, these mortgages were traded and repackaged so many times in so many different ways that the banks and servicers got lazy and sloppy with recordkeeping. They simply never thought they’d be called on it, it seems. Now they’re being called on it, and they’re in a bit of trouble.

When I represent a client in a foreclosure proceeding, the very least  I expect from the “lender” is that it be able to show that it is the lawful owner of my client’s debt. Increasingly, the lenders are finding out that bankruptcy judges get a bit irked if they can’t. Stay tuned.

As a follow-on to my post last Wednesday about some good stories NPR has run recently on the credit crisis, here’s another good one from the May 26 Morning Edition about a scam I’ve seen far too much of in my practice: the so-called “foreclosure rescue” industry. These are companies that hoodwink people facing foreclosure into signing over the title to their homes under the guise of helping people refinance their mortgages and fix their credit:

The schemers promise the homeowners that they can live in their houses mortgage-free, and then buy their houses back after a year. What their victims don’t know is that the scammers work with straw buyers to take out a bigger mortgage that essentially cashes out any equity in the house.

“These cases are very difficult to undo,” [lawyer Jessica] Attie said, “because the people who get to take out the cash often disappear. You can’t find them you can’t find the money and the property is left encumbered by a huge mortgage.”

Please, talk to an attorney before signing on to any plan that promises to help you save your home. There are a lot of people making such promises right now, and not all of them have your interests in mind. A knowledgeable bankruptcy and debt attorney can help guide you through the minefield and plan the strategy that works best for you.

As the mortgage meltdown continues to melt, it’s not terribly surprising that we’ve started to see the credit industry point the finger of blame at borrowers who took on loans they haven’t been able to pay back. As a recent trio of stories on public radio makes clear, however, the lion’s share of the blame should go to the lenders, investment banks, and brokers who devised and sold the financial instruments that turned the U.S. real estate market into something akin to a pyramid scheme.

On the April 3 edition of Fresh Air, University of Maryland law professor Michael Greenberger gave a clear and concise explanation of the causes and impacts of the mortgage and credit crisis that should be required listening for anyone who wants to understand how we got here and where we’re going. Listen here.

On May 9, Chicago Public Radio’s This American Life aired “The Giant Pool of Money,” a joint production with NPR News that explored the boardrooms and boiler rooms where these new, risky financial instruments were dreamed up and implemented. Listen here, or listen to the companion story on the May 9 All Things Considered here.

For a revealing look at who’s really to blame, read or listen to this story from the May 27 Morning Edition, about the lengths to which lenders and brokers have been willing to go to put people into loans they couldn’t afford:

A bankruptcy examiner in the case of the collapsed subprime lender New Century recently released a 500-page report, and buried inside it is a pretty interesting detail. According to the report, some investment banks agreed to reject only 2.5 percent of the loans that New Century sent them to package up and sell to investors.

If that’s true, it would be like saying no matter how many bad apples are in the barrel, only a tiny fraction of them will be rejected.

It seems all but certain that the stories that have already come out are just the tip of the iceberg. Stay tuned.

At Seattle Debt Law we consider bankruptcy a last resort option for homeowners who are behind on payments and/or facing imminent foreclosure. However, clients struggling with payment resets that can often increase their monthly mortgage payment by a third or more have few options. Luckily Congress is pledging to finally bring relief to homeowners through a government housing fund backed by Fannie Mae and Freddie Mac. Although the final bill has yet to come up for a vote, a deal has between reached by Senate Democratic and Republican leaders to bring a bill to the Senate floor and it should help homeowners with expensive adjustable-rate loans apply to refinance to stable 30-year fixed rate FHA mortgages.

It is too early to assess the impact of this bill on homeowners facing imminent foreclosure, but if there is a way to save your house, we will work with housing counselors to make it happen and keep your legal options for bankruptcy or predatory lending litigation open if the refinance or loan modification does not come through.

The New York Times’ Gretchen Morgenson wrote a great article last month rounding up a number of recent cases of bankruptcy court judges doing what the government seems unable to do: reviewing how and why homeowners are losing their homes, and holding lenders and servers responsible for their bad acts. The article covers the Louisiana case I wrote about yesterday, plus two others in Delaware and New York. The New York case is especially interesting to me because I have a current client dealing with exactly the same issue: the lender refused to accept a payment made by a borrower in bankruptcy, then tried to take action against the borrower for not making the payment!

Lenders have gotten away with these abuses for a long time, but I think these recent decisions show that the pendulum is beginning to swing back in favor of the consumer.