Cash-Strapped Homeowners Can't Make Payments

"The subprime lenders engaged in a battle for market share, so they offered lower rates to better-quality borrowers," said Michael Youngblood, managing director of asset-backed securities research at the investment bank Friedman, Billings & Ramsey.

Record Numbers, but Profits Take a Hit

On average, the mortgage industry issued $50 billion worth of subprime loans per month in 2005 -- an all-time record, according to Youngblood.

The lower interest rate mortgages were not as profitable, though, and many mortgage lenders lost money despite the increase in new business.

"The stocks got hammered," Youngblood said.

The industry solution was to adjust interest rate pricing and discontinue many of the low-interest mortgages they had offered in 2004 and 2005.

Subprime loans at higher interest rates increased as mortgage companies looked for a better return on their investments.

"But the mistake seems to have been that while the industry moved to more rational pricing, it attempted to keep the same pace of origination," Youngblood said. "Many of them made exceptions to qualify lower-quality borrowers."

A lot of those borrowers have had trouble keeping up their payments, hence the delinquencies and foreclosures.

Mortgage bankers point out that they have little incentive to sell mortgages to people who can't pay and eventually become delinquent or default.

"The mortgage company who services the loan has to absorb the cost of the delinquency or process or the foreclosure process, and that's a pricey undertaking," said Doug Duncan, chief economist for the Mortgage Bankers Association.

In fact, some subprime lenders have had a hard time returning to profitability, leading to a rash of sales of subprime mortgage companies.

Duncan said the increased use of new mortgage products had led to some of the delinquencies.

Lenders offering products like interest-only loans or "stated income" loans, in which the borrower need only state his or her income without documentation, are constantly evaluating their performance.

"A lot of these new products have no performance history, so the market will evaluate and adjust," Duncan said. "The mortgage companies will adjust the criteria they use to qualify borrowers."

Experts say the key for borrowers is to make sure they have enough extra cash on hand to continue making mortgage payments even if financial emergencies occur.

While homes can be a great financial investment, falling behind can lead to financial disaster.

"Of course hindsight is 20/20 for sure," Washburn said. "We've never been late on payments for anything, so we didn't intend to have any late payments on this house either."

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