The Coming Foreclosure Flood

foreclosure floodHeartened by the recent rise in home prices? Don't get too comfortable. Standard & Poor's, the credit-rating agency that tells investors what mortgage-backed securities are worth, reports that the increase was just an illusion. It predicts the nation is about to see a deluge of new foreclosures that will drive real estate values back down.

Blame the "shadow inventory" – nearly 1.8 million homes that are on the road to foreclosure but for all kinds of reasons haven't gotten there yet.
Many homeowners have fallen behind on their mortgages or stopped paying, but foreclosure has not yet arrived. Mortgage servicers, the folks who send you the bills and file for foreclosure when you can't pay them, are overwhelmed. Courts, too, are backed up. Mortgage modifications and foreclosure moratoriums have put off the day of reckoning for borrowers, but not forever. And unemployment is sabotaging more homeowners every day.

Out of more than $1.6 trillion in existing mortgages that were packaged into mortgage-backed securities by Wall Street, some $425 billion worth are extremely late on their payments, and therefore likely to go into foreclosure. Only a fraction of borrowers who fall seriously behind are able to catch up, with the help of a loan modification. And even then the majority end up falling behind again. That amount of bad mortgage debt has been spiking up every month, slowing down just a little thanks to the government's Home Affordable Modification Program, but still continuing to rise.

Meanwhile, even as the amount of unpaid mortgage debt rises, the number of foreclosed, bank-owned homes for sale has been holding fairly steady. That tells us that the number of foreclosures for sale on the market is actually just a sliver of all the ones that are really out there. S&P's chilling conclusion: "Overall, it is our opinion that recent positive housing reports should not be construed as a sign that the distress in the residential housing market is abating, but rather should be attributed to the temporarily limited supply of homes on the market."

The bottom line: just counting the homeowners who are currently behind on their mortgages, along with the existing number of foreclosures for sale, at the current pace it will take nearly three years to sell all the foreclosures out there. That doesn't include all the borrowers who haven't fallen behind yet but are going to, because of unemployment or because their Option ARM payments are spiking up or because they just decide to stop paying.

The shadow inventory is equal to half the size of the entire market of homes for sale. When it starts getting listed, expect home prices in areas with lots of foreclosures to plummet. Yes, more.
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