Risky second home loans seen weighing on U.S. housing

NEW YORK (Reuters) - Secondary homes are becoming a primary problem for the hard-hit U.S. housing market.

The housing industry is worried that a surge of foreclosures seen in the subprime sector could percolate upward. If it does, it is likely to show up next in the "Alt-A" loan market for second homes.

The fear is that when many adjustable rate mortgages are fixed at higher rates borrowers could fall quickly into arrears.

"Investors have been much more heavy users of option ARMs than of other kinds of products and they were in the Alt-A space," said Douglas Duncan, chief economist at the Mortgage Bankers Association, in industry trade group based in Washington D.C.

Whether for investment or vacation purposes, second homes backed by "Alt-A" loans are at a higher risk of defaulting than traditional mortgages.

"If you reside in a home, it is much more probable that you will make your payments on time as opposed to an investment property," Duncan said.

As a result, "you're going to see some slowing in second homes simply because you're not getting the equity accumulation in the first mortgage on the first home than you would've three or four years ago."

These "Alt-A" loans, which is short for "Alternative-A," often go to borrowers who cannot provide full documentation of income or assets to lenders. The option ARM, or adjustable-rate mortgage, offers a low payment that does not even cover interests costs, leaving borrowers each month deeper in debt.

Duncan said a lender told him they had to buy back 60 loans over the past five months and 100 percent of them were investor loans. A lender often has to buy back a loan from the investor if it goes delinquent within a set time period, which is within months usually.

Already there are signs of a slowdown after the boom of a few years back. Investment-home sales plummeted 28.9 percent to 1.65 million in 2006 from a record 2.32 million in 2005, according to recent data from the National Association of Realtors.

The combined total of vacation- and investment-home sales accounted for 36 percent of all existing and new residential transactions, down from 40 percent of sales in 2005, the NAR said in its annual Investment and Vacation Home Buyers Survey.

"There has been such a jump in inventories of vacant homes, which suggests there has been a big effect from second homes," said James O'Sullivan, economist at UBS Securities in Stamford, Connecticut.

"There is oversupply and that's arguably going to keep downward pressure on prices for a while," said O'Sullivan.

The NAR said last week it expects the median price for an existing home to slip 1.0 percent to $219,800 this year and to rise 1.4 percent in 2008. Last month, the group predicted a 0.7 percent price decline -- its first in nearly 40 years of record-keeping.

Prices for new homes, however, were expected to remain flat at $246,400 in 2007 and then rise 2.2 percent in 2008.

FICO A FARCE?

In general, "Alt-A" loans are between subprime and prime in credit quality, but some say they have a stronger link to subprime due to unreliable credit scores, dominated by the Fair Isaac Corp.'s FICO system. FICOs are relative measures of the creditworthiness for a person.

Mark Lefanowicz, president of E-LOAN, an online consumer direct lender, said during the housing market's peak around 25 percent to 30 percent of all loans were for vacation and investment properties.

"The fact is some of these investment properties, about 10 or 15 percent of them, were to subprime borrowers," he said. "Although they were getting an "Alt-A" loan, many of their FICOs could have easily moved to a subprime level after two months."

"Although they were getting an 'Alt-A" loan, many of them could have (scored at) a 620 FICO six months before. And many of their FICOs could have easily moved to a 620 FICO two months from now again." This is defined as the level where subprime begins.

"FICOs can move 30, 40, 50 points over the course of two to three months, so people with 680 FICOs could have been 620 FICOs three or four months ago," said Lefanowicz, who is based in Pleasanton, California.

But not all is doom and gloom in the secondary home market.

The NAR said vacation-home sales rose 4.7 percent to a record 1.07 million in 2006 from 1.02 million in 2005.

While investment sales cool down, demand for homes in desirable areas where vacation homes are prevalent is picking up, according to Diane Saatchi, senior vice president with the Corcoran Group, a residential real estate firm in New York.

"If you asked me to sum up the season (sales and rentals) I would say, consumer confidence in the Hamptons is at an all time high," she said. "Coupled with low interest rates and a strong local economy, after nearly 18 months of no activity in this segment, things are looking rosy."

(Additional Reporting by David Lawder)