The primary risk in the mortgage sector does not exist solely with sub-prime mortgages. Borrowers with low credit scores and previous bankruptcy are charged higher borrowing fees and interest rates over the life of the loan. The lenders expected some foreclosures. Apparently investors expected the word mortgage to dissipate the risk of the higher returns on the products.
Sub-prime mortgages are limited and balanced against loans with better ratings to borrowers with better credit ratings( Alt-A and Prime). Accurately rated sub-prime loans are capped at less than 10 percent of the lenders portfolio. That some borrowers defaulted and houses were foreclosed is no surprise. The risk assessment model currently utilized, underestimated the impact of the ARM mortgage adjustment and number of foreclosures.
The Alt-A mortgage sector it will be much worse. The high demand for houses, volume of loans, and appraisals within some areas could artificially inflate the sales price of the homes. The bulk of the mortgages in the more credit worthy Alt-A were ARMs with multiple mortgages. Purchases were made with a first mortgage of 80 percent of the purchase price at the appraised value, a 15 percent second mortgage, and the availability of a Home Equity Line of Credit approved for 25 percent of the purchase price.
Realty Trac has reported that the number of loans in default is more than twice the number of homes. Borrowers will lose their homes unless a credible way to refinance all existing liens on a property into a single mortgage. Lenders may take a significant loss on a first mortgage in the foreclosure process. Subordinate loans, the second mortgages and HELOCs will be the hardest hit and may be a TOTAL LOSS to lenders and investors.