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By December 2006, over 13 percent of subprime mortgage loans in the United States were delinquent, up sharply from about 10 percent during the housing boom just a few years earlier. For subprime adjustable-rate mortgages specifically, the delinquency rate exceeded 14 percent in December 2006, double the approximately 10 percent rate from September 2004. Metropolitan areas where house prices decelerated most sharply in 2006 experienced the largest increases in subprime delinquency rates, as borrowers found themselves unable to refinance out of adjustable-rate mortgages when rates reset higher.
The surge in delinquencies reflected multiple converging factors. After rising at an annual rate of nearly 9 percent from 2000 through 2005, house prices decelerated in 2006 and even fell in some markets. Simultaneously, interest rates on both fixed- and adjustable-rate mortgages moved upward, reaching multi-year highs by mid-2006 as the Federal Reserve raised rates to 5.25 percent. Subprime borrowers with ARMs who had counted on refinancing before their payments rose found they lacked sufficient home equity to qualify for new loans given stagnant or declining house prices. Many borrowers discovered they were underwater on mortgages from the moment they closed—"instant defaults" where people defaulted on their very first payment with no intervening job loss or medical emergency.
The delinquency surge translated rapidly into foreclosure action. In the fourth quarter of 2006, approximately 310,000 foreclosure proceedings were initiated, compared to a quarterly average of roughly 230,000 for the preceding two years—a 35 percent increase. Subprime mortgages accounted for more than half of the foreclosures started in the fourth quarter. The deterioration was most severe for mortgages originated in 2005 and 2006 at the peak of loose underwriting, when stated income loans, low documentation requirements, and predatory lending practices were most prevalent. Federal regulators had received explicit warnings throughout 2006 about the coming wave of defaults and foreclosures but delayed action due to industry lobbying, allowing the crisis to accelerate. By late 2006, the subprime meltdown was no longer a theoretical risk—it was underway and accelerating.