Housing Face another Risk from Alt-A Mortgages; Defaults Surge

Dean Nessen, a self-employed salesman, choosing a mortgage term was easy.  Nessen agreed to pay only the interest for a period of three years.  The salesman was not required to show proof of income and got a 6.25 percent interest rate.

For years later, Nessen suffered a business glitch and his interest rate went up to 10.6 percent.  The only recourse left to Nessen was to move out from his home in Michigan as he has no way of meeting his regular payment obligations.

Alt-A Could Fuel Intense Defaults

Alt-A mortgages have lured homeowners as the program requires no complicated documents such as proof of income.  This could fuel another intense wave of housing defaults and foreclosures thus delaying recovery of the housing sector which experienced its worst decline since the 1930’s.  

Data by gathered by Bloomberg showed that 16 percent of Alt-A loans given since January 2006 is facing payment defaults for at least 60 days.  It is expected that defaults will accelerate within the next year and could continue to spiral up until 2011.

Analysts said that Alt-A loans will be the next source of problems especially for issuances made in the last half of 2006 and early 2007.  A total of $1 trillion Alt-A mortgage loans have been issued to 3 million US borrowers.  This is much greater than the $855 billion sub prime outstanding loans.  Worse, 70 percent of Alt-A borrowers could have exaggerated their income levels.

The Washington based Fannie Mae has guaranteed $340 billion of Alt-A mortgages in the second quarter showing an extension of risks beyond the consumers and banks.  The loans recorded account for half of the company’s losses in the second quarter.  Freddie Mac on the other hand owned $190 billion of Alt-A loans or approximately 10 percent of its total mortgages holdings.  

On August 8, Fannie Mae announced that it will no longer accept new Alt-A loans after December 31st.    

The No Document Lure

Borrowers with higher credit scores got Alt-A loans carrying lower interest rates.  Alt-A propounded a no document policy.  This means that borrowers need not produce any documentary evidence of actual income.  These types of loans were initially offered to small businesses owners that face difficulties in producing proof of income or salaries.

As prices of homes climbed up and becomes out of reach of most buyers, Alt-A loans were issued to them on an ever accelerating rate.  To induce growth of the housing sector, the industry needs more borrowers and the only way to promote it is to reduce the credit scale.  Once the Alt-A loan opened, it was immediately subjected to abuse.

In 2005, the credit score for Alt-A loans was significantly reduced to 620.  This is far below the scores defined for sub prime holdings.  Alt-A loans were insured by the PMI Group, the second largest mortgage insurer in the United States.