Monday, December 10, 2007

Some Subprime Mortgage Facts

As Mrs. Angus and I dig our way out of ice sheets and downed trees, I recommend this Boston Fed working paper written by a couple of PhD students from Boston Univ.

The abstract: This paper provides the first rigorous assessment of the homeownership experiences of subprime borrowers. We consider homeowners who used subprime mortgages to buy their homes, and estimate how often these borrowers end up in foreclosure. In order to evaluate these issues, we analyze homeownership experiences in Massachusetts over the 1989–2007 period using a competing risks, proportional hazard framework. We present two main findings. First, homeownerships that begin with a subprime purchase mortgage end up in foreclosure almost 20 percent of the time, or more than 6 times as often as experiences that begin with prime purchase mortgages. Second, house price appreciation plays a dominant role in generating foreclosures. In fact, we attribute most of the dramatic rise in Massachusetts foreclosures during 2006 and 2007 to the decline in house prices that began in the summer of 2005.

So yes subprime mortgages for home purchase do end up in foreclosure "too often" and it's price declines, not interest rate increases, that are the key driver of foreclosures. Not only is the Paulson plan weird, it's pretty much misdirected and likely useless.


John Thacker said...

First, homeownerships that begin with a subprime purchase mortgage end up in foreclosure almost 20 percent of the time, or more than 6 times as often as experiences that begin with prime purchase mortgages.

My understanding is that a decent number of the recent subprime foreclosures were not "homeownerships that began with a subprime purchase," but subprime refinancing and home equity loans on homes that started out a s prime purchase mortgages. That is, people who saw home value increase and decided to "diversify" into assets by borrowing against the rising home values, but the extra amount borrowed pushed them into subprime territory (Or they went for ARMs, etc.). Presumably these were excluded from the above study.

I still think it's a bit of a leap to go from "subprime mortgages are much more likely to end in foreclosure" to "subprime mortgages are foreclosed 'too often.'" Would the over 80% who don't end up in foreclosure really have preferred renting instead?

The plan is misdirected on the basis of affecting the largest number of people who will be in foreclosure. It's a slightly different issue about whether it's directed at the most "deserving" or media-sympathetic foreclosures. People who can't make their payments are sympathetic. People who could make the payments but let the bank foreclose because they're underwater are less so, particularly if it's a second home that they were intending to flip.

The foreclosure I know in the DC area falls in the latter category-- someone bought a townhouse in 2005 while under construction, intending to sell at a profit. He couldn't, rented for a while, and then finally let the bank foreclose when it was clear that the house price declined. I know because a coworker was renting the townhouse and had to move.

So I think the question of proper direction of any plan takes more study.

Angus said...

Hi John:

(1) yes most subprime loans were for refinancing. the article makes that point as well.

(2)Ok, "too often" is a value judgement, but that is a high failure rate, no?

(3) I think the plan is misdirected in that falling house prices are whats driving foreclosures and a little rate freezing is not likely to affect that.

Dirty Davey said...

I don't know that "too often" is purely a value judgement--there's an empirical number in there somewhere.

Making a subprime loan is a classic case of accepting a higher risk (of default) in exchange for a higher potential return (interest rate).

So "too often" could--objectively--mean "at a rate such that the higher interest rates paid on non-defaulted loans are not enough to offset the losses to foreclosures on defaulted loans".

Anonymous said...

That's spot on, dirty. I'm concerned about the precident of the president/congress setting interest rates. There's a market established premium (currently ~.625%) to convert a 1-3 year arm to a 6-8 year arm and somehow that premium must/will be paid.

The key to Bush's plan is that it gives banks amnesty against investors, otherwise they wouldn't be so in favor of it.

Further, if a bank was more responsible and used other information to mitigate its risk on these mortgages, it will not be permitted to receive the risk premium it deserves. More moral hazard.

Kelly said...

I agree that homeownerships that begin with a subprime purchase mortgage end up in foreclosure almost 20 percent of the time. Subprime mortgages are boosting the housing sector, where predatory mortgage companies target consumers with bad credit ratings and low incomes. These consumers are often ineligible for the much lower prime market rates. The lenders prey upon the dream of homeownership among the working poor, offering to accept “high risk” borrowers. In turn, interest rates are inflated very high, so exorbitant that many borrowers cannot keep up with payments, penalties and other fine-print fees, particularly in the event of job loss, injury or illness in the family. A very high percentage of sub-prime mortgage and bad credit mortgages agreements end in desperate refinancing attempts, foreclosures and personal bankruptcy filings.