A number of factors played into the dramatic downward turns of the housing market, including predatory lending practices (see "The Subprime Fallout: Lending Practices" and "Targeting Women"), a massive increase in the use of subprime loans to finance home purchases, and inflated home values. In addition, many buyers during the boom have been losing their homes to foreclosure.

Understanding how so many consumers lost their homes to foreclosure and how it relates to other problems in the housing market will help in prevention of an outcome in your home buying experience.

During the recent housing boom, more home purchases were financed with interest only, variable interest rate, or non-traditional mortgage products. Such "creative financing" allowed more Americans to become first-time buyers or investors, thereby increasing the price of homes astronomically in a short period of time. Nonetheless, buyers fearful they would never be able to afford a home if they didn't buy during the boom became willing to take mortgages with riskier terms, based on the hope of future increase income and lower introductory payments.

Many people shouldering subprime loans with barely-affordable payments were hoping to refinance to avoid the new payments once the interest rate changed or principal payments were added. However, as housing prices stopped uncontrollably at the beginning of 2006, many homeowners found themselves unable to keep their homes, Keith Ernst, an attorney with the Center for Responsible Lending, a nationwide research and policy organization, suggests.

Unaffordable home prices were an initial thorn in the side of the inflated housing market. Would-be buyers shied away from unjustifiably expensive homes that could only be financed through subprime loans with shaky terms. As housing prices began plateau or even fall in some areas, the ability for homeowners who already had homes financed by loans with shaky terms were unable to refinance.

These owners were stuck with homes with little to no equity, and rising payments. Many defaulted, and the wave of foreclosures began. An increase in housing stock due to foreclosure not only lowered homeowner values, but also spurred another wave of lending industry instability as investors began selling off the mortgage securities that provide capital for loans.

In the end, the recent boom has given way to greater regulation in the lending industry (see "Loan Regulations in the New Housing Market"), and a return to more traditional, fixed-rate home loans.

References

"Subprime Lending Crisis"

"In a Credit Crisis, Large Mortgages grow costly"

Federal Trade Commission. FTC Consumer Alert: Avoiding Home Equity Scams

Democracy Now. Subrime Lending Crisis: Millions of Families Face Losing Their Homes to Foreclosure.

Floyd Norris and Eric Dash. In a Credit Crisis, Large Mortgages Grow Costly. New York Times, August 12, 2007.

David Streitfeld. Foreclosures May Spur Price Drops. Los Angeles Times, August 12, 2007.