Lenders Take Hit as Foreclosures Spread to Luxury Homes, Prime Borrowers

This ritzy home at 2189 Wynfair Ridge Way in San Jose, Calif., has four bedrooms, three bathrooms and a swell view of the Santa Cruz Mountains (actual picture at left). It's also in foreclosure. And given the depressed price of real estate in the region, the residence can almost certainly be yours for far less than the $2 million it sold for in 2006.

The foreclosure epidemic affecting lower-income households is now infecting luxury homeowners, along with other prime borrowers. Many wealthier people face the same squeeze as folks with more moderate incomes -- falling property prices destroys equity, tipping mortgages upside down and making it difficult to sell or refinance. That in turn is denting banks, high-end home builders and specialty lenders like Plaza Home Mortgage, which three years ago provided a $1.8 million loan to finance the purchase of 2189 Wynfair Ridge Way.

A recent survey by the Mortgage Bankers Association found that prime loans in the U.S. now account for one in three foreclosures, up from one in five a year ago. The percentage of prime loans in the foreclosure process rose to 3 percent, up 51 basis points from the first quarter and 158 basis points from the year-ago period. Delinquency rates on prime loans also are climbing.

As shown in the following chart from First American CoreLogic, which tracks real estate trends, delinquency rates on jumbo prime loans are rising, especially for mortgages originated between 2006 and 2008 (click on chart to expand). Obviously, not all of these mortgages are deteriorating. But it does suggest the foreclosure bug is spreading.

Nationally, foreclosures appear to have crested (for now). Yet as of August the number of people losing their homes hovered at near-record levels, even as real estate prices inched up in some parts of the country.

California remains a hotbed of foreclosure, driven by 12.2 percent unemployment. Although some cities in the state, such as Van Nuys, La Mesa and Santa Barbara, are seeing a major jump in home prices, foreclosures statewide reached a high in July, with roughly 108,000 filings for the month, up 50 percent from July 2008 levels, according to RealtyTrac. In Stockton, Calif., one in 74 housing units received a foreclosure filing.

Most homes that go into foreclosure are valued in the sub-$100,000 to $300,000 range, with an average foreclosure sales price of $192,031 (although that can vary significantly depending on the state). But the number of homes valued at more than $729,750, the limit for conforming mortgages in wealthier areas, entering foreclosure has surged in the last year.

In Vero Beach, Fla., for instance, Regions Bank recently foreclosed on a luxury gated community, resulting in a nearly $22 million judgment against the project developer. In Dallas, Wachovia Bank (now a part of Wells Fargo) is trying to sell land formerly intended to house a high-end residential community, along with a shopping mall.

Here's Robert Toll, CEO of luxury home builder Toll Brothers, in an Aug. 27 conference call to discuss third-quarter results in response to an analyst question about the impact of foreclosures on the company's business: "I am concerned. . . . There is no doubt the stats are what they are, and they are ominous with respect to the increase in foreclosures for prime borrowers and for some of what used to be the higher priced product."

One thing that may limit the number of luxury homes being foreclosed is the growing use of "short sales," in which lenders allow properties to be sold for less than the value of the mortgage. Banks lose more money on high-priced homes that go into foreclosure than they do on lower end properties, an incentive for short sales.

Developers also are pulling out the stops to draw buyers, offering cut-rate financing, property upgrades and other incentives in order to stoke demand. And foreclosure remains politically sensitive. The Obama administration has taken steps to help keep people in their homes, and that could bring relief for wealthier households, as well as for other homeowners.

Still, foreclosure rates are likely to remain elevated for months to come. More than 15 million U.S. mortgages, or 32 percent of mortgaged properties, are underwater, according to LoanPerformance.com. When you owe more on your mortgage than the home is worth, it doesn't take much -- being laid off, prolonged illness -- to fall into foreclosure. Wealthier homeowners typically have more of a cushion. But it's clear even they're not immune.

As for banks, they can cut their losses by moving more quickly to modify mortgages, especially by writing down part of the principal on troubled loan. So far, such efforts have been less than encouraging.

And if you're interested in the house at Wynfair Ridge Way, the opening bid is a bit north of $1 million. The auction is scheduled for Oct. 14. Could be a steal.

Graphics courtesy of Trulia.com, RealtyTrac and First American CoreLogic.