Foreclosure crisis spreads from subprime to prime mortgages

— -- The pace of prime borrowers going into foreclosure is accelerating, especially in states with mounting unemployment or property values that saw a big run-up during the housing boom.

It's a marked shift from earlier this year, when foreclosures were driven by defaults on subprime loans. And it has major implications — ravaging the credit scores of borrowers who once had unblemished records and dragging down property values in more affluent neighborhoods.

It also threatens to undermine the housing recovery.

"It's definitely a concern," says Brian Bethune at IHS Global Insight. "(Unemployment) is a major driver of foreclosures, and it will frustrate the housing recovery process."

In the first quarter, almost half of the overall increase in the start of foreclosures was due to the increase in prime, fixed-rate loans, according to the Mortgage Bankers Association (MBA). At the end of the fourth quarter, 2.4% of prime mortgages were seriously delinquent, more than double the 1.1% at the end of March 2008, according to a report by the Office of the Comptroller of the Currency and the Office of Thrift Supervision.

"In the beginning, the higher-end (homes) were a bit isolated," says Kevin Marshall, president of Clear Capital, a provider of real estate asset valuation. "But in the last several months, we're seeing a significant erosion in the higher-end homes. It's reached into the prime loans."

California, Florida, Arizona and Nevada represent 56% of the increase in foreclosure starts, including half of the increase in prime fixed-rate foreclosure starts, according to the MBA.

That coincides with states reporting some of the highest unemployment rates. In California, the unemployment rate in April was 11%, according to the Department of Labor. In Nevada, it was 10.6%.

Economists fear that further increases in unemployment could lead to more defaults on prime, fixed-rate loans.

That's what happened to Marvin Clayton, 47, of Waco, Texas. He lost income after his wife had a stroke and was unable to work. Then he lost his job a year ago. He's now behind on his 30-year, 5.78% prime loan and is facing foreclosure in July. He is currently trying to get another job in retailing.