Based on results from its recent mortgage study (see article), the Center for Responsible Lending (CRL) has predicted that one out of five subprime loans issued during 2005 and 2006 will fail, resulting in foreclosure for millions of American homeowners.

Dr. Mark Dotzour, chief economist with the Real Estate Center, says the real vulnerability in the residential housing market is in the entry-level housing category in regions where a large percentage of buyers have purchased with little or no down payment.

“In recent years, investor thirst for the higher yields of mortgage-backed bonds has allowed mortgage lenders to relax credit standards and issue loans that have a much higher risk of foreclosure,” Dotzour said. “It stands to reason that when you make riskier loans, you are going to have more foreclosures.”

Dotzour does not think mortgage companies or mortgage bond holders will be hurt when the expected tsunami of foreclosures hits. Instead, hedge funds, pension funds and endowment associations that have been chasing yield by accepting more risk, or large commercial banks offering complex derivatives to allow traders to hedge their risk in mortgage bonds are likely to feel the pinch.

“Nobody knows exactly where the ultimate risk really lies in the financial markets,” Dotzour said. “But one thing is for certain. Those who will be hit the hardest will be families that lose their homes to foreclosure.”

Source: Real Estate Center