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Mortgage Market Struggles to Gain Footing

After a difficult first and second quarter, the U.S. mortgage market is projected to improve in the third quarter of 2011. According to the Mortgage Bankers Association’s October forecast, home mortgage production is projected to improve 6.6 percent in the third quarter. According to the forecast, refinance originations are expected to increase 13.3 percent to $204 billion, while purchase originations are projected to fall 4.5 percent to $105 billion. The two-to-one ratio of refinance originations to new purchase originations suggests that mortgage demand continues to be driven by the favorable interest rate environment and not consumers seeking to purchase a new home.

While the improvement in the third quarter’s projected performance is welcomed, it suggests that there is considerable weakness in the U.S. mortgage market. According to the Mortgage Bankers Association, the quarterly average for total mortgage production in 2011 is $300 billion per quarter, well below the quarterly averages of 2009 and 2010, where total mortgage production stood at $499 billion and $393 billion, respectively.

The dramatic reduction in total mortgage originations suggests that low interest rates are having a diminished impact on driving refinance originations and increased demand for mortgages will have to come from increased demand for housing. However, significant headwinds exist that may prevent the demand for housing to improve in the immediate future.

Figure 1. 1-4 Unit Residential Mortgage Originations

One significant headwind facing the housing market recovery is the persistently high levels of seriously delinquent mortgages. While nonseriously delinquent mortgages (30-89 days) have shown signs of improvement recently, falling 34 basis points over the last quarter to 4.49 percent of all mortgages, seriously delinquent mortgages remain stubbornly high. Even though seriously delinquent mortgages—defined as mortgages that are 90 days or more past due plus mortgages in foreclosure—have come down from their 2009 peak, recent data suggest that the decline has halted. In fact, in the third quarter of 2011, seriously delinquent mortgages rose 4 basis points to 7.89 percent of all mortgages. The level of seriously delinquent mortgages is primarily driven by the inventory foreclosures; consequently, the level of seriously delinquent loans will remain high until foreclosures begin to fall.

Figure 2. 1-4 Unit Residential Mortgage Deilnquency Rates

Due to the number of risky mortgages made from 2004 to 2008 and the reduced support for at-risk consumers, it may not be realistic to expect the level of foreclosures to decline in the immediate future. A recent study from the Center for Responsible Lending suggests that we may be only halfway through the foreclosure crisis. According to the study, 8.3 percent mortgages (3.6 million loans) made between 2004 and 208 are at an immediate risk of foreclosure. Consequently, the number of seriously delinquent mortgages may actually increase in the near future.

Additionally, the potential increase in foreclosures comes at a time when some supports put in place during the financial crisis may be phasing out. According to data released by the Department of Treasury, the number of trial modifications started under the government’s HAMP program fell to 15,000. Moreover, on a quarterly basis, the number of trial modifications started in the third quarter of 2011 was significantly lower than in the second quarter of 2011. According to the Department of Treasury, the number of new trial modifications under the HAMP program in the third quarter stood at 52,000—the lowest level since the start of the program. The persistent decline in the number of new trial modifications suggests that there is a larger effort to sustain current permanent modifications instead of starting new ones.

Figure 3. Number of HAMP Trial Modifications Started per Month

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