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For many homeowners, the worst fear is fading

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Police tape marked as a Foreclosure Free Zone is seen outside the foreclosed home of Marie Elie in Elmont
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Police tape marked as a Foreclosure Free Zone is seen outside the foreclosed home of Marie Elie in Elmont, …

Real-estate experts aren’t using the dreaded F word nearly as much as they did a few years ago. And it’s not because of a politeness outbreak.

Foreclosures spiked during the housing bust that ran from 2006 to 2012, perhaps the most distressing aspect of the whole grueling downturn. The number of foreclosure filings peaked in 2010, with nearly 2.9 million homes entering default, according to research firm RealtyTrac. The number has drifted down since then, falling to about 1.4 million foreclosure filings in 2013.

That’s reassuring, but there’s even better news: The foreclosure rate improved markedly during the last two months of 2013, and by at least one measure it’s back to levels that might even be considered normal.

What's "normal?"

It’s hard to know what “normal” is in the housing market, of course, since the devastating bust was preceded by a fantastical boom in which nearly anybody could get a mortgage and home values rose like Jack’s beanstalk. But foreclosures, at least, are now falling to levels last seen before the recession. The foreclosure rate in December, for instance, was one filing for every 1,136 housing units, according to RealtyTrac. The last time it was that low was July 2006, when the unemployment rate was 4.7% and the start of the recession was still a year and a half away.

Foreclosure rates could still drift back up in 2014, since they tend to be higher in summer months than in the winter. But virtually all trends are now moving in the right direction: Employment is picking up, rising prices are helping homeowners regain lost wealth, and government programs have even started helping some stressed owners hold onto their homes.

The foreclosure rate began to soar in 2007 partly because a lot of people who bought homes during the boom couldn’t afford them in the first place, making it inevitable they’d fall behind on payments once home values stopped rising by double digits. Yet the surge of foreclosures made the housing bust far worse than it might have been in an ordinary recession.

There were so many defaults in places such as Florida and southern California that fire-sale prices dragged down the value of virtually every other home. That pushed millions of otherwise-solvent homeowners “under water,” meaning they owed more on their home that it was worth. To sell, they’d have to absorb a steep loss, which reduced the inventory of homes available for sale along with the ability of people to move where the economy might be better.

An epidemic

That foreclosure epidemic — almost a standalone crisis within the broader housing downturn — is still distorting the housing market. Celia Chen of Moody’s Analytics writes that the spike in foreclosures “helped drive the severe house price correction from 2007 to 2009,” while the foreclosure fade “has helped drive the rebound more recently.” That helps explain why home prices rose by about 12% in 2013, rather than a more modest single-digit gain — because of foreclosures, prices over-corrected during the bust, which means they over-rebounded during the first year of the recovery.

The next 12 months are shaping up as a return to normalcy in the housing market, provided there are no nasty surprises. Mortgage rates — now around 4.5% for a 30-year loan -- have begun to creep back to more-typical levels as the Federal Reserve has started to back away from its extraordinary stimulus policies. Banks such as J.P. Morgan Chase (JPM) and Wells Fargo (WFC) report that refinancing activity has dropped sharply, but that may prompt them to make up some of the lost revenue by easing credit standards and making purchase loans to more borrowers.

As the job market improves, more people ought to have the cash — and gumption — to take the risk on buying a home. If nothing else, population growth will generate more people who need housing, lifting the market. Chen of Moody’s Analytics predicts home-price appreciation will slow to 3.3% during the next decade — a modest, Goldilocks pace that will bring welcome stability back to the housing market. It can’t happen soon enough.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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