The meltdown in the subprime mortgage sector continued last week, raising concerns that home buyers with impaired credit will face higher rates and far fewer options in the months ahead.

Following the December bankruptcy filing of Ownit Mortgage Solutions, a major subprime lender, a steady stream of mortgage firms have either announced cutbacks in subprime production, quarterly losses, or sharply-elevated delinquency rates. Some major banks, such as Washington Mutual, have announced staff reductions in subprime and moved to tighten underwriting rules.

Giant HSBC Holdings PLC, the country's highest-volume subprime originator, set aside an extra $1.76 billion recently to cover unanticipated losses from delinquencies and foreclosures. New Century Financial, another top originator, said rising delinquencies would like lead to a quarterly loss.

Last week, ResMae Mortgage Corp. of Brea, California, filed for bankruptcy, citing investor demands that it buy back $308 million in defaulting loans. San Diego-based Accredited Home Lenders Holding Co., announced losses of $37.8 million for the fourth quarter, compared with $43 million in net income in the fourth quarter of 2005.

Also last week, new questions arose in Washington about mortgage bond investors' willingness to continue funding the subprime sector to the extent that it has in recent years. At a conference organized by the Hudson Institute, two mortgage securities market experts-Joseph R. Mason, an economics professor at Drexel University, and Joshua Rosner, managing director of hedge fund adviser Graham Fisher & Co.-said the relaxation of lending standards during the housing boom years has led to a rising tide of subprime borrower delinquencies, and could send investors scurrying to the exit door, especially if home values also decline.

That, in turn, could push subprime interest rates to borrowers much higher, and severely restrict some borrowers' ability to buy houses at all.

Subprime mortgage originations now account for 20 percent of all new loans, up from a tiny sliver a decade ago. Roughly 45 percent of all subprime borrowers use their loans to buy a home, according to Michael Fratantoni, an economist with the Mortgage Bankers Association, and 25 percent of those purchasers are buying their first home.

Any major flight of bond investors from the subprime mortgage securities market, in other words, would have negative repercussions not only lenders and borrowers, but on realty agents and builders as well.

The tightening of standards already underway is reducing the availability of "piggyback" mortgages-combined first lien and second lien loan programs that cut downpayment requirements to 5 percent or zero with no private mortgage insurance. The cutbacks in investor appetite are also reducing opportunities for home buyers with spotty credit histories to use limited-documentation and stated-income mortgage financing, sometimes called "liar loans" in the industry. Mortgage wholesalers also report sharply-reduced investor appetites for loans that "layer" risk-combining, for example, low FICO scores with high debt-to-income ratios.

According to Mason and Rosner, investors' retreat from subprime could affect the field for years. In that case, where could subprime borrowers and home buyers turn? One resource might well be the Federal Housing Administration (FHA) program, which now offers higher maximum loan amounts, much lower rates than subprime, low downpayments, no consideration of FICO scores, and very generous underwriting standards. However, FHA does not accept stated income; it requires documentation of income and assets.

Published: February 19, 2007

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consmer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.