Second Mortgages Caused Rise in Foreclosure Properties
The rise in second mortgage loans is one of the major causes of the large numbers of foreclosure properties that subsequently caused the collapse of the housing market and the nationwide economy, according to Michael LaCour-Little, finance professor at the California State University in Fullerton.
LaCour-Little said that mortgage loans taken out by borrowers who really could not afford to pay them even at the start also caused the collapse of the housing market, but not as much as the effect of second mortgage loans.
He also said that the abrupt and fast acceleration of home prices is also to blame as very high home values enticed many homeowners to take out second mortgage loans.
He explained that many analysts and homeowners believe that home appreciation is good for the market because it cuts down the risk of default. But according to him, home appreciation is bad, especially if the appreciation is artificial – meaning home prices reverse their upward trend abruptly after a short time.
LaCour-Little argued that price appreciation entices homeowners to borrow money on their home equity. If the economy goes bad and home values go down, the borrowers are left with nothing but big loans and bargain-priced homes – which is what happened in the current foreclosure crisis.
When home values fell down to their lowest levels, hundreds of thousands of American homeowners became underwater borrowers – the values of their homes fell far below the amount of their loans.
LaCour-Little said that he based his conclusions on his study of foreclosure properties in the first weeks of every November since 2006 in the California counties of Los Angeles, Orange, Riverside, San Diego and San Bernardino.
From his study of foreclosure properties, he discovered that a lot of people took out home loans to purchase homes and simultaneously took a second home loan to finance the whole cost of their home purchase.
From his studies of 2,358 foreclosure properties in November 2008, the former owners of 79 percent of the properties took out a second home loan. More than 50 percent of the houses were bought before 2005 and 2006 when home values peaked.
At the time the properties were foreclosed in 2008, the average home loan owed by the former owners was $551,000, about 170 percent of the average home value.
According to LaCour-Little, the big second home loans taken out by homeowners during the boom caused houses to turn into foreclosure properties when home values fell down to their lowest levels.
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