Different loans for different zones: Patterns in mortgage type distribution

A geographic mapping of subprime and Alt-A loans in the Phoenix metropolitan area has revealed some unexpected results: these risky mortgages are not scattered, but cluster in certain cities and neighborhoods. Subprime loans, for example, are heavily concentrated along the Interstate and on the periphery of the urban area, while the fashionable northeast sector of the city is home to a higher number of Alt-A loans. "Alt-A loans, which are low-documentation and no-documentation loans, are almost exclusively concentrated in Scottsdale," notes Anthony Sanders, a W. P. Carey professor of finance and real estate.

A geographic mapping of subprime and Alt-A loans in the Phoenix metropolitan area has revealed some unexpected results: these risky mortgages are not scattered, but cluster in certain cities and neighborhoods. The fashionable northeast sector of the city, for example, is home to a higher number of Alt-A loans than any other area.

"Alt-A loans, which are low-documentation and no-documentation loans, are almost exclusively concentrated in Scottsdale," notes Anthony Sanders, a W. P. Carey professor of finance and real estate. "The wealthiest part of the Phoenix metro holds the highest concentration of no-documentation loans, which is not really a problem because if that market goes south, these homeowners will be better able to hold onto the mortgages without default given their higher average household income."

Alt-A loans are a riskier type of debt, but lenders were willing to make large mortgages in this category available to wealthier buyers. In the lender's point of view, the risk profile of Alt-A loans fell somewhere between prime and subprime. Borrowers had clean credit histories and strong credit ratings, thus elevating the quality of the loan, but on the credit downside, increased risk issues arose because of high loan-to-value and debt-to-income levels.

"These are small-business people who don't relish disclosing all their income," says Sanders. "Alt-A is almost a de facto measure of the market for small business ownership. Very clearly, a doctor who has been in practice for 20 years is not going to be asking for a low-documentation loan unless of course there are some mitigating circumstances," says Sanders.

"A lot of these borrowers are involved with starting up an Internet or technology firm, or have moved here from places like Los Angeles to set up a new business." In contrast, very little of this type of mortgage debt was issued in lower income areas such as Queen Creek, parts of Gilbert, South Phoenix and Tolleson-Avondale.

Concentrations of subprime

The general view of Phoenix is that the metro area is riddled with subprime loans, but that isn't the reality. "The perception that subprime loans are spread across the Phoenix metro is just not correct," says Sanders. "We find subprime heavily concentrated in just two sectors. The first can be found along the Interstate, particularly going west and north from downtown. That's the low-income and older housing approximate to the freeways. Many of these loans are refinancings."

The second area, Sanders adds, are in the new developments on the periphery of the urban area, such as in the western metro communities of Buckeye and Goodyear, and the towns of Queen Creek and Gilbert to the south. "That's the more lower- to middle-income, newly-constructed-home effect," Sanders added. Interest-only, adjustable rate mortgages, generally referred to as IO-ARMs, are considered the most risky mortgage product in the market.

These are also concentrated in the wealthier Phoenix metro areas, stretching from Cave Creek and Carefree south through Paradise Valley into Scottsdale, and in the very middle class cities of Mesa, Chandler and Gilbert. "IO-ARMs represent two different types of borrowers," says Sanders. "They are used by 'flippers,' people who bought houses with little money down, and have an adjustable-rate mortgage without any principal pay-down because they want to refinance or sell the residence within three years.

Secondly, buyers using IO-ARMs want to get into neighborhoods on the cheap — meaning they want to buy that lovely house in Paradise Valley but they want to minimize their mortgage payments." ARMs typically offer lower payments than fixed-rate mortgages and IO-ARMs boast even lower payments than regular ARMs. The IO-ARMs concentration bifurcates the Phoenix metro, because very few occurred west of the downtown.

Cities in the west, such as Glendale, Peoria, Tolleson and Sun City, show fewer than 24 percent of total loans falling into the IO-ARM category. But in the Northeast Valley of the Sun, IO-ARMs represent 35 to 50 percent of all loans. IO-ARMs are scary loans because they can easily blow up, Sanders explained. The danger with IO-ARMs is a function of the fact that borrowers are not paying down principal.

If the loan resets at a higher interest rate, households on the financial precipice could have trouble making the payment. Worse yet, these borrowers tend to default when their IO-ARM resets during a housing price drop. Homeowners who know that their houses are worth less than what they paid often conclude there's no point in hanging on.

Lenders are finding that rather than restructuring the upside-down mortgage, homeowners walk away — because they have little or nothing invested in the principal. "The lender or investor really gets nailed on these, because they bear the downside loss," says Sanders.

"The courts are overwhelmed when too many people are defaulting and many judges will not actually pursue the borrowers for the amount of money the lenders are out of pocket." Sanders says that Scottsdale and nearby chi-chi townships are fortunate because this part of the Valley of the Sun has not experienced the steep decline in housing prices that some places in the United States — and Phoenix metro — have suffered.

Impact on investors

As far as pure investment purchases are concerned, the geographic dispersion is very narrow. "We hear a lot about Canadian investors coming into Phoenix and buying real estate, or Los Angeles buyers who want to escape to Phoenix and play golf. These people tend to be condominium purchasers," say Sanders. "Out-of-town, or even out-of-the-country, buyers of investment homes tend to do so in very specific places."

In Phoenix, this phenomenon results in the greatest geographic concentration of all the mortgage categories. Follow Route 51 north to Highway 101, and then continue on the 101 east and south through Scottsdale to Tempe and the 2002, and that's it — an inner circle of investment homes defined by those roadways. "The investment concentration map can almost be called a condominium map," says Sanders.

And where are those condos located? Most can be found near golf courses and the resort hotels. One other area of the Phoenix metro considered popular for investment purchases can be found around Sun City West. "These are different types of purchases, primarily by adult children who acquire a property then lease it to their parents," says Sanders. "That's more like gifting of houses."

ARMs open wide

For the wider ARM category there is no discernible pattern: ARM investments occurred throughout the Valley of the Sun. "ARMs are everywhere and there are lots of them," says Sanders. "More than 50 percent of all the mortgages in Phoenix are adjustable rate, which means that there is a lot of potential for payment shock if rates go up."

He adds, "Everyone in Maricopa County should thank their lucky stars for Ben Bernanke, chairman of the Federal Reserve. Without him there would be a lot of pain and suffering in Phoenix. Bernanke keeps lowering those prime rates and that typically translates into ARM resets that are more reasonable." Links to Sanders' maps may be found in "Additional Reading."

Bottom Line:

• Alt-A loans in the Phoenix market are centered in wealthy areas like Scottsdale where there are large numbers of entrepreneurial business people who need to get the best home loan possible without divulging too much of what they are doing in their business operations.
• Subprime loans are not scattered throughout the Phoenix metro area, but are concentrated in low income neighborhoods along the highways.
• Like Alt-A, interest-only ARMs (IO-ARMs) are found mostly in the fashionable northeast valley.
• Investor-owned properties are clustered in the area of the city with the most golf courses and resort hotels.