New Wave of Foreclosures Will Sink the Housing Market Rebound

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The long-anticipated housing market rebound will hit a speed bump this year as the number of foreclosures rises again.

With January's mammoth $26 billion settlement between five major banks and a group of state attorneys general, foreclosures that had been held up for a year or more are now moving forward.

The spike in foreclosures will arrive just as other data, such as the 5.1% increase in new construction permits reported on Tuesday, had begun to point to a housing market rebound.

"We expect to see foreclosure-related sales increase in 2012, particularly pre-foreclosure sales, as lenders start to more aggressively dispose of distressed assets held up by the mortgage servicing gridlock over the past 18 months," Brandon Moore, CEO of RealtyTrac, told CNN Money.

RealtyTrac's February report showed new default notices – the first step in the foreclosure process – were up 1% from January. Default notices increased dramatically in some states, such as Pennsylvania (35%), Florida (33%) and Indiana (37%).

"The pig is starting to move through the python," Daren Blomquist, director of marketing for RealtyTrac, told CNN Money.

Distressed sales already account for about one out of three U.S. home sales.

The National Association of Realtors (NAR) reported this week that 20% of home sales in February were foreclosures and 14% were short sales.

In a short sale, an owner who owes more on their home than it's worth agrees to sell for less, with the bank agreeing to accept the loss.

That's a far cry from a normal housing market, when distressed sales are less than 5%.

For 2012, RealtyTrac predicts a 25% increase in foreclosures, which will push the portion of distressed sales even higher.

And the picture doesn't figure to improve for quite some time. Paul Dales of Capital Economics estimates as many as an additional 3 million foreclosures over the next several years.

The Uneven Impact on the Housing Market

However, the impact of this wave of foreclosures will be felt unevenly.

All of the states that saw increases in new default notices were those in which the courts play a role in foreclosures. The robo-signing issues addressed in the bank settlement occurred almost exclusively in such states.

States that don't use a judicial foreclosure process didn't accumulate a backlog. In fact, foreclosure activity in those states was down 5% in February from the previous month, and down 23% from the February 2011.

But among the 26 states that use a judicial foreclosure process, activity rose 2% in February from the month before. Foreclosure activity was up 24% from the previous year.

That leaves little room for optimism in hard-hit states such as Florida.

The loosening logjam in distressed sales will increase the downward pressure on prices by adding to inventory and lowering home values. Discounts on foreclosure sales typically range from 20%-30%.

And unlike some other housing market data, home prices haven't shown much evidence of turning upward. Home prices fell 4% in 2011 on top of the 30% decline since the peak of the housing bubble in June 2006.

Given the impact of the bank settlement, the outlook for home prices in 2012 isn't great.

"Enough homes are in the foreclosure pipeline to keep house prices falling through much of this year," Celia Chen, a housing economist atMoody'sAnalytics, told the Los Angeles Times.

While that may be good news for first-time homebuyers, it's terrible news for the 25% of homeowners who owe more on their mortgage than their homes are worth.

And it can only trip up the housing market rebound many analysts have been seeing in other recent housing data.

Construction of single-family homes is 18% above year-ago levels. Permits for new single-family homes were up 4.9% in February. Existing home sales in February were up 8.8% from last year, and were up in 2011 to 4.26 million, from 4.10 million in 2010.

But none of that will be able to overcome a tsunami of foreclosures, at least for this year.

"While beginning to improve, a strong, sustained recovery in the housing market, especially the important single-family sector, still appears to be a ways off," Steven Wood, president of Insight Economics LLC, told Bloomberg News.

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