Are the Latest Foreclosure Numbers Good News or Bad News?

The Business Desk: The headline on Bloomberg’s foreclosure story this morning: “U.S. Foreclosure Filings Jump 23% to Record in Third Quarter.”

The headline on Reuters: “Foreclosures Fall for Second Straight Month.”

Both it turns out, are correct. But don’t mistake the latter headline for good news.

According to RealtyTrac, the real estate data firm that we consulted for a story we’re running on Thursday’s NewsHour, U.S. foreclosure filings – which include mortgage default notices, home auctions and home repossessions by banks — climbed to a record 937,840 in the third quarter this year. That translates to one out of every 136 U.S. households. (That’s an increase of 5 percent from the previous quarter, and 23 percent from the same time last year.)

July’s numbers were the highest ever recorded, followed by August’s, with September’s a close third (hence Reuters’ rosy headline).

As RealtyTrac’s Rick Sharga explained to us in an e-mail, “What we’re seeing now are remnants of the initial subprime meltdown exacerbated by rising levels of unemployment, which are pushing all types of loans – including prime – into foreclosure. Assuming unemployment peaks in Q4 2009 or Q1 2010, we should see foreclosures related to job loss peak around the end of 2010, followed by the wave of Option ARMs and ALT A loans.”

What does that all mean, you ask? Well, ALT (short for alternative) A loans are mortgages that are less risky than subprime, but way riskier than prime. That’s because they were often granted without income documentation.

Option ARMs – also called “pick-a-payment” loans – are adjustable rate mortgages that typically offer the borrower four initial monthly payment options: a specified minimum payment (with unpaid interest added to the principal), an interest-only payment, a 15-year fully amortizing payment, and a 30-year fully amortizing payment. The fact that most Option ARMs during the boom years were offered with very low teaser rates, like 1 percent, means that most of those borrowers qualified for much larger loans than would otherwise have been possible. And when those teaser rates expire? A nasty surprise for those with rising incomes in a rising market, a disaster when paychecks and property values are heading south.

So, what about that “wave” Rick Sharga mentioned? Well, he reports that the interest rates on the overwhelming majority of ALT A and Option ARM loans are scheduled to reset sometimes between April 2010 and September 2011. If the small percentage of those high-risk loans that have already reset are any indication, they will be defaulting at pretty high rates, writes Rick.

“The one variable none of us can nail down right now is how many of the loans in the ALT A and Option ARM pool will already have entered foreclosure before they reset. So determining the degree to which this last wave may or may not dwarf the original subprime wave is open to wide speculation. This is really the first time we’ve had back-to-back waves of foreclosure cycles, which has made projecting trends (to say nothing of dealing with the problem) very difficult.”