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The Bubble Bursts
Ryan and Amanda Adams seemed the walking embodiment of upward mobility. At 25, Amanda had left her job as a bookkeeper to become a real estate agent in South Lake Tahoe, California. Soon she was selling two houses a month. That convinced Ryan, who had been laid off from his sales job, to get into the field as well.In one year, their income soared from $60,000 to $160,000. They bought new cars -- a Mercury Mariner for her, a Montego for him -- went sailing in the Bahamas, and took their daughter, Aaralyn, to Disneyland.
After falling in love with a $379,000 three-bedroom ranch on a roomy lot, Amanda turned to a mortgage broker she knew for financing. You probably know where this story is headed: The Adamses took out a subprime "no income verification" adjustable rate mortgage (ARM). For five years they'd pay only interest, then their 6.2 percent rate would reset annually, and they'd start paying down the principal. All the couple had to do was estimate their annual earnings.
Although concerned about the $50,000 balloon payment at the end of the 30-year term, they signed the papers and put $2,500 down. They had $20,000 in the bank for emergencies. What could go wrong?
By the time the real estate boom went bust in early 2006, Amanda was pregnant. "We never thought we'd go six months without making a sale, but that's what happened," she says.
The couple fell behind on their bills. Ryan's car was repossessed. When their son, Daylan, was born, they couldn't pay the $3,500 hospital bill. Unable to sell their home, which had decreased in value by $79,000, Ryan got a job loading UPS trucks, while Amanda took the kids to the office to save on sitters. But on $40,000 a year, they couldn't stave off the inevitable. The bank gave the Adamses several weeks to move out, then took possession, listing the house for $229,000.
The family now lives in a trailer on Amanda's parents' property. "Our credit was destroyed," says Amanda. "We couldn't rent an apartment or get utilities." The most painful part was trying to explain the situation to Aaralyn, then four. "I felt terrible tearing her away from everything familiar because of our mistakes."
The Explosion
Every three months, 250,000 new families enter into foreclosure. And things are about to get worse. "We expect another two million foreclosures over the next 18 months," says Gus Faucher, director of macroeconomics at Moody's economy.com. "This is the nation's biggest drop in housing prices since the Great Depression."
Everyone -- not just those with sub-prime loans -- will feel the pain. Need money for home improvements or college? Don't count on using your house as a piggy bank; 60 percent of banks are making it harder to get home equity lines of credit. Many banks have raised standards on other consumer loans, which could be a problem if you want to finance a new car.
The credit crunch is hurting businesses, too, leading to layoffs and fewer new jobs. That could spark more foreclosures, since at least 10 percent of families are upside-down on their mortgage: They owe more than their home is worth.
How did we get into this mess? In 2002, after the dot-com boom went bust, investors were seeking the next big thing. One of Wall Street's answers was mortgage-backed securities, which paid higher returns than Treasury bills. Because these securities were considered low-risk investments, pension funds, universities, and even small-town governments bought them.
As demand grew, mortgage brokers began courting people who'd had trouble getting home loans because of poor credit or low income. The brokers had nothing to lose if the risky loans didn't work out. "Nobody asks for your commissions back if 90 percent of your borrowers later go into foreclosure," explains Christopher Cruise, a loan officer at amerisave.com.
Banks weren't risking their own money either. They sold the mortgages to investment firms that in turn hired other companies to service the loans. Already, several subprime lenders, like New Century Financial, have gone bankrupt. Countrywide is looking wobbly. In March, as banks pulled back on lending, Ben Bernanke, chairman of the Federal Reserve, slashed interest rates for the sixth time in six months. "There will probably be some bank failures," he said matter-of-factly.
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