Defaults Decline as Rates Drop, Values Climb


Staff Reporter

Lower interest rates and a surprisingly buoyant housing market got many troubled homeowners off the hook in 2001, driving loan defaults in L.A. County to a 10-year low.

And while defaults, which generally are a lagging indicator of economic performance, likely will climb this year, the increase is not expected to reach the steep levels of the mid-90s, according to John Karevoll, an analyst at DataQuick Information Systems.

A total of 24,531 L.A. County homes last year received notices of default, a 4 percent drop from 2000, according to San Diego-based DataQuick. That figure was the lowest since the firm began tracking defaults in 1992.

"We're dragging along the bottom. The default numbers might edge up a little bit," said Karevoll, who foresees a 5 to 10 percent increase in defaults for 2002.

"With a nationwide slowdown, we don't expect the same economic growth this year as in previous years," he said. "That may nudge people into risky territory as far as personal finances are concerned."

Ten years ago, that nudge was more of a shove. In 1992, L.A. County defaults topped 35,000, peaking at 52,321 in 1996. The jump coincided with a drop in home values, as well as an unemployment rate that was regularly in the double-digits between 1992 and 1994 and was still as high as 8.5 percent in mid-1996.

Since then, the inverse relationship between home values and notices of default has only been reinforced. After notices of default rose by 47 percent between 1992 and 1996, default levels fell by 21 percent in 1997, the first time in many years that average home values went up. Since 1996, annual defaults have dropped by 53 percent while home values have appreciated by 38 percent.

Housing prices help

Despite the economic softening, the median sale price of a Los Angeles County home last year was $224,000, up 13 percent over 2000, according to DataQuick. That rise, combined with lower interest rates, has enabled more homeowners facing default to either refinance at a more manageable rate or sell their homes in the several months between the notice of default and foreclosure.

When a borrower falls two to three months behind in mortgage payments, a trustee is appointed by the lender to issue a notice of default to both the county and the borrower. After the notice goes out, there's a 90-day period for the borrower and lender to resolve the matter. After that, the trustee publishes a note of foreclosure and prepares the property for auction.

Roughly a third of the county default recipients ultimately lose their homes, down from about 50 percent in the mid-90s, according to Karevoll.

Because of the strong housing market, the chance of a homeowner owing more on a house than its present market value is far less than in the previous recession, when home values dropped by 24 percent between 1991 and 1996. As a result, selling the house is a viable alternative to going into default.

"If people have to leave the area because their job disappears, there are buyers lined up to buy the house," said Leslie Appleton-Young, chief economist for the California Association of Realtors.

Also a factor in the low default figures are mortgage rates, now hovering around 7 percent, that were less than 6 percent at one point late last year. Lower rates mean that the real cost of a mortgage is lower than it was a decade ago.

"There's been 32 to 33 percent inflation over the past 10 years, so in real dollars, the cost of for a household to own a home is lower now than it was in '89 to '91," said Karevoll, referring to double-digit interest rates at the time.

Warning signs?

But increased unemployment levels and a bounce in interest rates is expected to flatten home prices toward the end of the year. That would mean an end to several years of lower default levels, according to Michael Carney, professor of finance and director of the Real Estate Research Council at Cal Poly Pomona.

"The sustained increases in home prices we've seen over the past five to six years will be coming to an end fairly soon," said Carney. "The economy is not looking too good."

Unemployment notwithstanding, a key determinant in how much defaults and foreclosure rates end up rising is the change in interest rates, according to Sung Won Sohn the chief economist at Wells Fargo & Co.

"Let's say it goes over 8 percent, that would push up the foreclosure rates," said Sohn. "Some of these mortgages are adjustable rates, and some of the people may not be able to pay the (higher) monthly payments."

But with the recession largely hitting lower-income groups that are less likely to own homes, default and foreclosure rates are less likely to spike downward. "We have lost a lot more low paying part-time jobs than high paying full time jobs," said Sohn.

Karevoll said a number of factors would have to occur before default and foreclosure rates start approaching their mid-90s levels. Besides having the county's unemployment rate rise to the 7.5 to 8 percent level it was 6.1 percent in December interest rates would need to hit double digits and home values would need to start decreasing, he said. "The things that precede (a jump in) defaults just aren't happening right now," said Karevoll.

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