“Defaulting on a mortgage causes temporary excess liquidity. This excess liquidity masks the true risk of the consumer as he goes through the foreclosure process. Certain consumers who defaulted on a mortgage in the recent recession only did so because of the recession. They are otherwise good credit risks,” the report states. It goes on to conclude that, “the ability to identify ‘life event’ mortgage defaulters versus chronic defaulters can open up profitable, low-competition target segments.”

The study, entitled “Life After Foreclosure and Hidden Opportunities,” tracked 129,000 consumers over a 12 to 17 month period. It shows that nearly 40% of the home owners who defaulted on their mortgages between February 2009 and August 2010 obtained car loans, personal loans, or lines of credit, and the majority secured credit cards. The TransUnion report further reveals that mortgage defaulters perform the same, if not better, on certain lending accounts when they open them further along in the foreclosure process. “This new market segment that the recession created is an important one for lenders to understand. They have the potential, today, to be stronger and more reliable customers.”

Although banks wouldn’t openly admit it, James Chessen, chief economist at the American Bankers Association, says mortgage defaulters are viewed as attractive customers for new loans as long as they are current on all other debts. For example, a Wells Fargo spokeswoman says the bank would consider lending to someone who defaulted on their home mortgage if the default is an isolated incident and the borrower is willing and able to repay the loan. One-time mortgage defaulters are viewed as a safe risk compared to borrowers who miss payments on multiple loans. Mortgage-only defaulters, says Chaouki, “are less risky than they appear. Lenders will want to lend to these people in the future.”

Marcus Stanley, policy director at the public interest advocacy group Americans for Financial Reform, says lenders are taking into consideration the housing bubble and bust that caused responsible borrowers to default on their mortgages. According to market researcher RealtyTrac, since 2006 nearly 4 million homes in the U.S. faced foreclosure, with many of them being “strategic defaults” where homeowners who could afford to pay their mortgage walked away because the value of their homes were substantially less than what they paid for them.

However, the lending environment for mortgage defaulters isn’t all rosy. Loans and credit cards come with high interest rates. According to John Ulzheimer, president of consumer education at the credit-monitoring site SmartCredit.com, mortgage defaulters can expect car loan rates as high as 19% from the average 4.7% and credit card interest rates between 20% and 25% from the average 15%.

The economic crisis has a lot to do with Americans’ concerns toward home ownership. A survey that tracks home ownership finds that in December 2010 only 64 percent of people felt a house is a safe investment, compared to 83 percent in 2003, prior to the housing collapse. “If we’ve learned anything from this mess, it’s that housing is not a risk-free investment,” Michelle Meyer, a senior economist at Bank of America Merrill Lynch Global Research points out. “Everyone knows someone underwater in their mortgage or struggling to sell a home.” The U.S. Census Department finds that the home ownership rate fell to 66.5 percent in the fourth quarter of 2010, the lowest in more than a decade.

According to CoreLogic Inc., a real estate information company based in Santa Ana, California, as of December 2010, an estimated 11 million homes in the U.S. were worth less than their mortgages. Furthermore, a March 2011 report finds an additional 2.4 million borrowers had less than 5 percent equity in their homes. But real estate agents are hoping low home prices and borrowing costs will lure buyers back. Mortgage rates recently released by mortgage financier Freddie Mac puts the average mortgage rate for a 30-year fixed home loan at 4.80 percent and the 15-year average rate at 4.02 percent. “If you can jump through the hoops to get a mortgage, and there will be hoops, then this is an amazing time to purchase real estate,” notes Robert Stein, former head of the U.S. Treasury Department’s Office of Economic Policy. “There are going to be a lot of people kicking themselves a few years from now because they didn’t take advantage of the low prices and the low mortgage rates.”

Based on median U.S. income, property prices and mortgage rates, homeownership affordability is at its best yet. The median home price dropped 32 percent from its 2006 peak. “We expect that purchase activity will pick up slowly as the improvement in the job market eventually leads to greater willingness to buy,” the Mortgage Bankers Association anticipates. The group expects home sales to increase 4.1 percent in 2011 and 5.9 percent in 2012. The latest figures from Freddie Mac support the group’s optimism. Sales of existing homes below $100,000 increased 3.7 percent in March and mortgage applications rose 5.3 percent in the week ending April 15. “People will still aspire to own their own homes,” said Lea, the finance professor at San Diego State University. “They’ll just be a lot more practical about it.”

According to the report, an improved labor market led to a drop in mortgage payment delinquencies across all home loan types during the last quarter of 2010. Mortgage delinquencies declined to 8.2 percent, the lowest since 2008, from 9.1 percent in third quarter 2010. Loan payments that were one payment overdue dropped to the lowest level since the recession began in 2007, and mortgage loans that were three or more payments overdue dropped to 3.6 percent, compared to 5 percent in the first quarter of 2010. “First-time delinquency is very much a measure of distress in the employment system,” said Jay Brinkmann, chief economist for the Mortgage Banking Association. “I see all of this as pretty good news. It looks like we’ve clearly hit the turning point.”

But that turning point might stall in 2011. The Mortgage Bankers Association report also finds that the number of mortgage loans in foreclosure increased to 4.63 percent, compared to 4.4 percent in the previous quarter. The report attributed the increase to lenders putting a temporary hold on seizing homes from delinquent borrowers because of fraudulent or incomplete documents. Another issue delaying the housing market recovery is the large volume of low-priced, foreclosed homes on the market that are undermining home values. Last month, almost half of all home purchases were distressed properties. “We have to clear out those distressed properties before we can talk about any kind of housing market recovery,” said Guy Cecala, publisher of Inside Mortgage Finance Publications. “There are signs of improvement, but I think it’s a little early to break out the champagne.” Cecala estimates that it would take more than two years to clear foreclosed homes off the market, adding “and that’s assuming that no more foreclosures are added to that inventory.”

Despite the decline in mortgage loan delinquencies for the last three months of 2010, credit reporting agency TransUnion expects the mortgage delinquency rate to flat line during 2011 because of declines in housing prices. According to the Standard & Poor’s/Case-Shiller 20-city home price index, home prices in most large U.S. cities fell to their lowest point since the housing market collapse. “The data would say that these things (delinquency rates and falling housing prices) are clearly related,” said Tim Martin, who follows the housing market for TransUnion financial services. “There’s pressure on prices, and if prices drop, it tends to lead to delinquencies,” he said.

The Mortgage Bankers Association report also finds fewer people applying for home loans, even though mortgage rates for 30-year loans dropped for the first time in five weeks to 5 percent. Rates for 15-year mortgage loans also declined to 4.27. “The housing market is struggling to regain traction despite still historically low rates,” said Frank Nothaft, vice president and chief economist for Freddie Mac. According to the Mortgage Bankers Association report, loan applications for the week ending Feb. 11 decreased 9.5 percent, the lowest point since November 2008. In addition, applications for mortgage refinancing loans dropped to 64 percent, the lowest level since May 2010. Matt Howlett, an analyst at New York’s Macquarie Group Ltd., says refinancing would only improve if “there were some other government stimulus that hasn’t already been constructed. And that just seems unlikely.”

The Obama administration’s current housing rescue program is already running far behind expectations. The initial goal was to reach at least 3 million to 4 million people by the end of 2012. But according to U.S. Treasury Secretary Timothy Geithner, “we won’t come close to initial estimates.” He said the taxpayer-funded incentives offered to mortgage servicers to reduce monthly payments for homeowners struggling to make mortgage loan payments “have not been powerful enough, in all cases, to overwhelm all of the muck that these servicers have created.”

While lenders could absorb the cost of the increased risk fee, they are expected to incorporate it into the costs of the loan. Amy Bonitatibus of Fannie Mae said the risk fee increase is “intended to more accurately reflect changing risks in the housing market.” However, mortgage lending experts say the higher fees could make it difficult for some consumers to qualify for home loans through Freddie Mac and Fannie Mae.

While Freddie Mac and Fannie Mae get ready to implement their higher risk fees, the White House and officials from the banking industry are quietly holding talks about mortgage reform and the role the federal government should take to prevent another financial crisis. It’s evident from the housing collapse and the government’s takeover of Freddie Mac and Fannie Mae – at a taxpayers cost that could well exceed estimates of $151 billion – that the loan guarantee structure established during the Great Depression is not working. According to insiders, the mortgage reform talks are centering around several think tank recommendations.

The latest recommendation on mortgage reform from the Center for American Progress, a leading liberal think tank, backs a plan similar to one proposed last year by the Mortgage Bankers Association, a lobbying firm that represents the major banks in the country. Their mortgage reform plan would replace Freddie Mac and Fannie Mae with new private, for-profit companies. These firms, which banks would be allowed to have ownership in, would buy the mortgages from banks and sell them to investors in the form of securities. However, the government would guarantee investors against losses, which means if mortgages default, the government, not the firms, would be on the hook for the loss. In such a setup, the banks connected to these firms and Wall Street make a nice profit while taxpayers take on all the risk.

Proponents of the plan say home mortgages would be more easily attainable, have low interest rates and less fees since banks are not taking on any of the risk. In addition, the loss to taxpayers for mortgage defaults would be minimized by an insurance fund, similar to the FDIC, that these new firms would pay into. Yet the question remains whether it would be possible to achieve the same results by subsidizing housing through tax credits instead of a complex mortgage financing system. The Cambridge Winter Center for Financial Institutions Policy think tank argues in its report that tax subsidies are more effective than a taxpayer-backed housing finance system.

Clearly, policymakers and banks are coming from very different angles on the issue and the question is whether they can find common ground without forgetting about affordable housing and the taxpayer.

Especially considering the Fed recently cut the Fed Funds rate target to 0%, which signals that we’ll almost certainly be facing some serious inflation in the near future as a result. And, as everyone knows, rising inflation equals rising mortgage rates.

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