Greedy lenders, naive buyers, and sinking home values have driven millions into foreclosure. What it means for you, your community, and your own financial health.

The Bubble Bursts

Ryan and Amanda Adams seemed the walking embodiment of upward mobility. At 25, Amanda had left her job as a bookkeeper to become a real estate agent in South Lake Tahoe, California. Soon she was selling two houses a month. That convinced Ryan, who had been laid off from his sales job, to get into the field as well.

In one year, their income soared from $60,000 to $160,000. They bought new cars -- a Mercury Mariner for her, a Montego for him -- went sailing in the Bahamas, and took their daughter, Aaralyn, to Disneyland.

After falling in love with a $379,000 three-bedroom ranch on a roomy lot, Amanda turned to a mortgage broker she knew for financing. You probably know where this story is headed: The Adamses took out a subprime "no income verification" adjustable rate mortgage (ARM). For five years they'd pay only interest, then their 6.2 percent rate would reset annually, and they'd start paying down the principal. All the couple had to do was estimate their annual earnings.

Although concerned about the $50,000 balloon payment at the end of the 30-year term, they signed the papers and put $2,500 down. They had $20,000 in the bank for emergencies. What could go wrong?

By the time the real estate boom went bust in early 2006, Amanda was pregnant. "We never thought we'd go six months without making a sale, but that's what happened," she says.

The couple fell behind on their bills. Ryan's car was repossessed. When their son, Daylan, was born, they couldn't pay the $3,500 hospital bill. Unable to sell their home, which had decreased in value by $79,000, Ryan got a job loading UPS trucks, while Amanda took the kids to the office to save on sitters. But on $40,000 a year, they couldn't stave off the inevitable. The bank gave the Adamses several weeks to move out, then took possession, listing the house for $229,000.

The family now lives in a trailer on Amanda's parents' property. "Our credit was destroyed," says Amanda. "We couldn't rent an apartment or get utilities." The most painful part was trying to explain the situation to Aaralyn, then four. "I felt terrible tearing her away from everything familiar because of our mistakes."

The Explosion
Every three months, 250,000 new families enter into foreclosure. And things are about to get worse. "We expect another two million foreclosures over the next 18 months," says Gus Faucher, director of macroeconomics at Moody's economy.com. "This is the nation's biggest drop in housing prices since the Great Depression."

Everyone -- not just those with sub-prime loans -- will feel the pain. Need money for home improvements or college? Don't count on using your house as a piggy bank; 60 percent of banks are making it harder to get home equity lines of credit. Many banks have raised standards on other consumer loans, which could be a problem if you want to finance a new car.

The credit crunch is hurting businesses, too, leading to layoffs and fewer new jobs. That could spark more foreclosures, since at least 10 percent of families are upside-down on their mortgage: They owe more than their home is worth.

How did we get into this mess? In 2002, after the dot-com boom went bust, investors were seeking the next big thing. One of Wall Street's answers was mortgage-backed securities, which paid higher returns than Treasury bills. Because these securities were considered low-risk investments, pension funds, universities, and even small-town governments bought them.

As demand grew, mortgage brokers began courting people who'd had trouble getting home loans because of poor credit or low income. The brokers had nothing to lose if the risky loans didn't work out. "Nobody asks for your commissions back if 90 percent of your borrowers later go into foreclosure," explains Christopher Cruise, a loan officer at amerisave.com.

Banks weren't risking their own money either. They sold the mortgages to investment firms that in turn hired other companies to service the loans. Already, several subprime lenders, like New Century Financial, have gone bankrupt. Countrywide is looking wobbly. In March, as banks pulled back on lending, Ben Bernanke, chairman of the Federal Reserve, slashed interest rates for the sixth time in six months. "There will probably be some bank failures," he said matter-of-factly.

Help on the Way?

The Way Out?
Solving the crisis has become a contentious debate. Aid that will help some borrowers refinance mortgages at lower rates should soon be in place, as well as tax credits for people who buy houses out of foreclosure. But Democrats say this is way too little. Under the most ambitious plan, from Massachusetts Democrat Barney Frank, the government would insure up to $300 billion of failing subprime loans to encourage lenders to restructure at more affordable rates.

Most Republicans, on the other hand, are reluctant to bail out borrowers who took out irresponsible loans. They emphasize that a home purchase is, as Treasury Secretary Henry Paulson put it, "a long-term investment, a place to raise a family and put down roots in the community," not a way to make a killing on quickly rising values. The Administration argues that the biggest beneficiaries of a major bailout would not be homeowners but the lenders who made risky loans. The debate over the coming months will focus on how even entirely innocent homeowners and financial institutions may be ensnared. Meanwhile, in a move with bipartisan support, the government plans to mandate improved disclosure of home-loan terms and tougher licensing for brokers.

While Washington debates the big picture, grassroots groups are stepping in with solutions. Bruce Marks, CEO of Boston's nonprofit Neighborhood Assistance Corporation of America (NACA), would like predatory lenders and investment firms held accountable: "The mortgage industry and banks like Bear Stearns paid out over $10 billion in bonuses to their executives, so why should taxpayers bail them out?" More to the point, NACA has persuaded Countrywide and Citigroup to restructure thousands of ARMs and other loans at risk of foreclosure. One reason the banks agreed: Foreclosure costs them anywhere from $40,000 to $50,000 per house in legal fees and real estate commissions and forces them to pay for upkeep on abandoned homes. The beauty of it, says Marks, who is trying to sign on other banks, is "it doesn't cost the taxpayer a cent."

In the Trenches
For struggling homeowners, will any of this come soon enough? Fernando and Keia Guia, of Las Vegas, learned in 2006 that the $1,046 minimum payments on their two ARMs hadn't even covered the interest, and they were getting $916 deeper in debt every month. At the same time, the value of their home sank by $85,000.

Countrywide, their lender, warned the Guias in January 2007 that their payments would soon double. With Fernando working two part-time jobs and with two young children, the Guias were in no position to manage that. They tried unsuccessfully to refinance and to sell. When Keia called Countrywide, an employee suggested they simply walk away and send their keys to the bank -- a scenario called jingle mail.

Just when the Guias thought they'd lose the house, NACA worked out a 5 percent loan, fixed for 28 years, with monthly $1,800 payments that include taxes and insurance. "They're going to have to tighten their budget and get some more employment," says Bruce Marks, "but they'll be building equity. This adjustment is like going from the dark of night to a sunny day."

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ON THE RISE
The number of houses in foreclosure has increased by 141% since 2005.
2005 - 532,833 2006 - 717,522 2007 - 1.3 Million

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View Points

Everyone's fingerprints are on the gun.
--Victoria Reider, Executive deputy secretary, Pennsylvania Department of Banking

We're nowhere near the bottom of this problem, and nobody knows exactly where the bottom is.
--Mortimer B. Zuckerman, Editor-in-chief, U.S. News & World Report, and real estate developer

The American dream for individuals has now become the nightmare for cities.
--James Mitchell, Jr., Charlotte, North Carolina, councilman; president of the National Black Caucus of Local Elected Officials

The hundreds of thousands of people about to be thrown out on the street want the government to stand with them. That's good for the people. That's good for the economy.
--U.S. Senator Bernie Sanders, Vermont

We must not harm our economy through solutions that, however well intentioned, further erode the foundation of the nation's housing market, hurt homeowners who are meeting their mortgage obligations, or prolong the correction.
--Brian Montgomery, Assistant Secretary, U.S. Department of Housing and Urban Development

Owning a home is not a birthright. Borrowers and lenders need to recognize that for some people, the American dream of homeownership is just that -- a dream.
--Christopher Cruise, Loan officer, amerisave.com