Mortgage delinquencies seen peaking in 2008

NEW YORK (Reuters) - The credit quality of U.S. mortgages is set to weaken substantially through the remainder of 2007 and well into next year, with delinquencies peaking in mid-2008, Moody's Economy.com said on Thursday.

Delinquencies will peak at 3.6 percent of all mortgage debt outstanding in the summer of 2008, up from 2.9 percent in this year's first quarter, according to the study by the consulting firm based in West Chester, Pennsylvania.

"This will result in substantial financial damage," Mark Zandi, chief economist of Moody's Economy.com, said during a teleconference after the release of the study.

Subprime, "Alt-A", jumbo interest-only and option adjustable-rate mortgages, or ARMs, account for about 25 percent of all mortgage debt outstanding, or around $2.5 trillion. Of that amount, approximately $1.4 trillion is at serious risk of default, he said.

Of those mortgages, about $460 billion should actually end up defaulting some time this year or in 2008 and of that, $113 billion will be a loss to investors after recovery efforts are made, said Zandi.

That's more pessimistic than Federal Reserve Chairman Ben Bernanke, who last week estimated losses between $50 and $100 billion.

The deterioration of mortgage credit quality can partly be blamed on falling U.S. house price prices, with all parts of the housing market experiencing declines. The high-end of the market, however, is holding up a bit better than the middle- and low-end, said Zandi.

The erosion of mortgage credit quality will also be due to the fact that many borrowers will soon be facing measurably higher mortgage payments. October will be the peak reset month when about $50 billion worth of mortgages will be adjusted to reflect higher interest rates, he said.

"As the resetting mounts, that will put significant financial pressure on many of the subprime borrowers and this pressure is already very intense," he said.

About 2.5 million first mortgage loans are expected to default over the next two years, with credit problems rising sharply in California's Central Valley, Florida, and the metropolitan areas of Las Vegas, Phoenix, Washington, and New York, according to the study.

The findings are based on consumer credit files from the credit bureau Equifax and cover 200 metropolitan areas in the United States.

Moody's Economy.com said the subprime adjustable-rate mortgage, or ARM, segment will be the hardest hit, with the rate of mortgages in foreclosure forecast to hit 10 percent by mid-2008, up from the current 4 percent.

For comparison, the previous peak of 6 percent was reached soon after the September 11, 2001, terrorist attacks, after which the rate fell to a low of 2.5 percent in the summer of 2005.

Subprime ARM loans originated in the fourth quarter of 2006 are expected to be the poorest performing loans, with the foreclosure rate peaking at just under 20 percent in the fall of 2011. This is more than three times the peak foreclosure rate that is forecast for loans originated in 2004.

"The economic fallout from the devolving mortgage market will be substantial, but conditions would be even worse if not for a continued generally sturdy job market," said Mark Zandi, chief economist of Moody's Economy.com, in a press release.

There are about one million housing units above the level appropriate to a well-functioning housing market and this glut of supply will weigh on house prices for some time, he said.

Moody's Economy.com estimates that about 750,000 of the one million excess units are existing homes, with the remaining 250,000 units representing unsold new homes.

Moody's Economy.com is an independent subsidiary of the Moody's Corp. and provides economic research and consulting services to businesses governments and other institutions.