Subprime Mortgages Crossing Income and Credit Strata

To date, the face of the subprime borrower as portrayed in the media was nearly always the urban low income borrower who was just trying to live the American dream, was the victim of an unscrupulous borrower, good people facing a few economic shocks, didn’t realize how high their payment would be when their ARM reset, etc. However, a recent WSJ study illustrates how subprime loans crossed all socioeconomic levels, geographic regions, ethnic lines, etc. In fact, there were even high concentrations of subprime loans in affluent areas with high housing appreciation rates; areas that now lead the nation in foreclosures.

At first glance, one might think that if affluent to high income people were taking out subprime loans, that it must mean that these people had bad credit, financial struggles, etc. The truth is that many affluent buyers used subprime loans to purchase more home then they could afford with a prime loan, make speculative real estate “investments” and/or to withdraw more equity from their home than they could with a prime HELOC. In short, a lot of the subprime problem comes from people whose greed (or hubris) caused them to make bad financial decisions, instead of just buying a smaller house with a sensible prime loan, not withdrawing all of their home equity, not engaging in irresponsible speculation, etc.

In other words, the subprime problem wasn’t just concentrated amongst low income buyers with bad credit that weren’t financially savvy enough to know what they’re getting into; a lot of affluent, prime borrowers gambled with subprime loans and are now losing their shirts. Subprime loans weren’t just mortgages with high interest rates originated to people with bad credit, they were also high cost loans originated to affluent people with good credit, who were looking to borrow more money than sensible lending standards would allow.

From the Wall Street Journal:

To examine the surge in subprime lending, the Journal analyzed more than 250 million records on mortgage applications and originations filed by lenders under the federal Home Mortgage Disclosure Act. Subprime mortgages were initially aimed at lower-income consumers with spotty credit. But the data contradict the conventional wisdom that subprime borrowers are overwhelmingly low-income residents of inner cities. Although the concentration of high-rate loans is higher in poorer communities, the numbers show that high-rate lending also rose sharply in middle-class and wealthier communities.

[…]

As home prices accelerated across the country over the past decade, more affluent families turned to high-rate loans to buy expensive homes they could not have qualified for under conventional lending standards. High-rate loans are those that carry interest rates of three percentage points or more over U.S. Treasurys of comparable durations.

The Journal's findings reveal that the subprime aftermath is hurting a far broader array of Americans than many realize, cutting across differences in income, race and geography. From investors hoping to strike it rich by speculating on condominiums to the working poor chasing the homeownership dream, subprime loans burrowed into the heart of the American financial system -- and now are bringing deepening woe.
[…]

The Journal compared the fastest-growing high-rate loan markets to the rankings compiled by foreclosure-listing providers RealtyTrac Inc. and ForeclosureS.com. In Stockton, Calif., for example, high-rate loans accounted for 33% of total home-loan volume last year, up from 13% in 2004. During the first half of this year, the Stockton area had 8,169 foreclosure filings, or one for every 27 households. According to RealtyTrac, of Irvine, Calif., that makes Stockton the nation's foreclosure capital.

Seven of the 10 large metro areas now struggling with the highest foreclosure rates -- including Miami, Detroit and Las Vegas -- saw borrowers barrel into high-rate loans much faster than the country as a whole. In a forthcoming study in the Journal of the American Planning Association, Daniel Immergluck, an associate professor at Georgia Institute of Technology in Atlanta, found a similar pattern between foreclosures occurring in early 2006 and cities with high subprime lending in 2003.

[...]

Higher-income home buyers began using such loans for larger purchases. Among borrowers characterized in the data as white with annual income of at least $300,000, the number of high-rate loans jumped 74% last year, the numbers show. The average high-rate loan grew 10% to $158,000 last year, compared with a 1% rise in the average size of all home loans. The 2006 data include records from 8,886 lenders nationwide, which generate an estimated 80% of U.S. home mortgages.

[…]

The high-rate loan data likely understate the potential peril posed by mortgages with low teaser rates. Under federal rules governing disclosure, some subprime teaser loans do not show up as having high rates. Lenders weren't required to report loan-pricing details until 2004.

A couple of takeaways from the article:

1) Assuming the Professor’s study is valid, there very well could be a delay of 2-3 years between a surge in subprime lending and a corresponding peak in the number of foreclosures. If my suspicion is correct, (that this pattern occurs in affluent areas more than in low income ones), then in some of the areas hardest hit by foreclosures, we’re actually only seeing the foreclosures from 2003-2005’s loans, and haven’t seen 2006-2008s foreclosures yet.

2) It’s quite likely that a lot of ARMs were originated to prime borrowers with prime teaser rates and subprime prime reset rates, which are currently off the radar with respect to statistics on subprime loans.

3) If you consider points #1 and #2, along with the 100s of billions of ARMs slated to reset between now and the end of 2008, it stands to reason that the housing slump could last into the next decade.

The dialogue around the mortgage crisis, housing slump, etc, needs to change, completely. There needs to be some level of differentiation between uneducated buyers, predatory lenders, lenders using bad judgment and prime borrowers who just made bad financial decisions. Blaming lenders is fun and easy, but some of the borrowers are just as guilty. You can’t blame the gun manufacturer if you shoot yourself in the foot.

The best way to combat the mortgage crisis with respect to preventing it from happening in the future isn’t regulation, bailout programs, legislation, etc. The solution is a combination of better educated borrowers, tighter lending standards and a change in homeowner psychology. People need to view their homes as where they live not investments, borrowers need to utilize sound lending standards and consumers need to understand that using an “end around” to take on a larger mortgage than they can get via prime lending channels is probably the path to financial ruin. Greed will always exist, but if a greater degree of common sense, lending standards and financial acumen was employed, we wouldn’t have had the mortgage crisis in the first place.

Sources:

- The Wall St. Journal “The United States of Subprime” – Rick Brooks and Constance Mitchell Ford, October 12, 2007

Disclosure: as of the writing of this article, the Author doesn’t own shares in any of the firms mentioned in this or the referenced article.

Comments

[Joyce :]

I have always thought that most of such instruments were used by high-income earners willing to take the risk that the interest rate would go up since their monthly income would also rise.
Over the last 5 years, I've had a number of questions regarding alternative financing instruments: Who ultimately owns them? When will the interest rate be recalculated? How is the new interest rate calculated? Your article answered some of these.

In order to maintain the assessment values of their "inventory" of real estate, states & other municipal entities need to have borrowers stay in their home by lenders' renegotiating loans. If borrowers (voters) are foreclosed & evicted, will municipalities help their voters find other housing? So such muncipalities may lose inventory value & also have a greater debt loan. I discovered that many alternative instruments were ultimately bought by China, pension funds & insurance companies -- none of whom seem likely to want to renegotiate individual loans with individual borrowers.

2007 Oct 12 03:37 PM

[fakepaychec...:]

I say if you cant beat them.....join them! GET THE COMMISSIONS YOU DESERVE!!! www.fakepaycheckstubs.... seems like you can get any bad credit home or car loan simple fast and easy! if you are needing a proof of income letter or any other ways to make or create the perfect pay slip cheque then you are on the right track! www.fakepaycheckstubs.... it is simple, for you can use the easy to use fake pay check stubs anytime anywhere even if you need a fast cash pay day loan. How about refinancing or consolidating all of your bills! this is it! if you want fake id or need fake pay check stubs for the job then i suggest using the best site on the net www.fakepaycheckstubs....

2007 Oct 14 03:33 PM

[patski:]

hmmm, all these people making 150k and up suddenly defaulting?

r u sure it wasnt' a bunch of 50k people lying about their income?

Mortgage borker: "how much do you make?"

Starbucks Trainee: Ahh, like, $130k/yr....

2007 Oct 15 03:33 PM