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Prime borrowers catching subprime ills

Countrywide Financial's quarterly report revealed a spike in delinquencies. Why even high-quality borrowers are falling behind.

By Les Christie, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- The subprime mortgage meltdown has begun to spread to prime loans as even credit-worthy borrowers have started to fall behind on payments.

On Tuesday, Countrywide Financial (Charts, Fortune 500), the nation's largest mortgage lender, attributed a big drop in profits to a spike in delinquencies among prime borrowers of "second-lien loans," including home equity loans and home equity lines of credit.

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These loans were often "piggybacked" onto first mortgages to help finance low- or no-down home purchases. They were also taken out by prime - but overburdened - borrowers to help pay high housing bills or fund their lifestyles.

In the past, mortgage delinquencies were tied to personal problems or basic economic reversals, such as a job loss. Today, many delinquencies can be traced to unaffordably high home prices.

"Unable to afford their own homes, [borrowers] turned to increasingly risky mortgage products," said Amy Klobuchar, a member of the House of Representatives from Minnesota, speaking Wednesday before a hearing of the Joint Economic Committee examining the national foreclosure crisis.

Some home buyers, caught up in red-hot markets and afraid of getting locked out of homeownership forever, overpaid for houses.

As long as prices escalated, they were able to tap the added equity in their properties to cover debts.

But now home prices are falling - off more than 2 percent from their highs, according to the Case Shiller home price index.

Meanwhile, lenders are cutting back on second-lien loans. When homes go into foreclosure, first-lien lenders lay claim to proceeds from a sale. Second-lien can get stuck with a total loss.

According to Keith Gumbinger, vice president of mortgage information publisher HSH Associates, many of the delinquent second-lien borrowers bought into home ownership "with high loan-to-value ratios." They owed almost as much as the property was worth.

"These second-lien mortgages may be less likely to be paid off, especially if the borrower is having trouble paying off the first mortgage," Gumbinger said. And if lenders insist on payment, they could drive borrowers into foreclosure and get nothing back.

The increase in delinquencies of prime second-liens doesn't mean that prime borrowers overall are defaulting - it is still relatively rare for prime borrowers to default on primary mortgages.

But most second-lien loans come with adjustable rates - and interest rates have been rising. Since a lot of the borrowers were already at the edge of affordability, any increase hurts.

And they tended to be used more in "bubble" markets, areas where prices went through the roof and affordability suffered.

According to Doug Duncan, chief economist of the Mortgage Bankers Association, mortgage delinquencies now cluster under two very different categories. The first consists of home owners buffeted by personal problems, such as job loss, divorce or illness. That is more likely to occur in regions suffering systemic economic problems, areas where plants have closed or undergone mass layoffs. That is happening today in many older industrial towns in the Midwest, where the auto industry has been taking its lumps.

But there also has been a big increase in foreclosures in economically vibrant regions, ones with growing populations and steady job growth, such as California, Arizona, Nevada and Florida. That's new.

In the MBA's latest survey, covering the first three months of the year, it found large increases in delinquencies among the riskiest classes of loans, such as subprime hybrid loans (up to 15.8 percent from 14.4 percent last quarter and 12 percent a year ago), many of which were taken out to buy expensive homes in hot markets.

That's mirrored by Countrywide's delinquency stats for its prime second-liens, which in the three months ended June 30, jumped to 5.4 percent compared with 2.2 percent a year ago.

Duncan pointed out that Countrywide has a large market share in California, where it's based, and the frothiest of all the bubble markets. The second-lien loans were likely buffeted by the same winds that ruffled so many subprime mortgages.

Nationwide, delinquencies rates for prime fixed-rate loans, in contrast, actually fell to 2.19 percent during the first three months compared with 2.27 percent for the three months ended Dec. 31.

Many of these prime, fixed-rate loans bought homes in markets that enjoyed slow, steady growth; prices never became as unaffordable as in some of the speculative housing markets and buyers were not forced to take on added risk to become home owners. Top of page