Calhoun statement: "Losing Ground" release


Center for Responsible Lending
December 19, 2006

This is Mike Calhoun for the Center for Responsible Lending.  We appreciate the participation of the National Association of Realtors and the Leadership Conference on Civil Rights, and we also thank you in the media for calling in. 

The research we're releasing today shows that subprime lenders are selling the most dangerous loans to the most vulnerable borrowers, creating the largest rash of foreclosures in the modern mortgage market.  This conclusion is driven by some powerful numbers:

2.2 million subprime home loans made in recent years have already failed or will end in foreclosure.  These foreclosures could cost as much as $164 billion – an amount that could send more than four million children through college.  Our study shows that one in five families who get a subprime mortgage today will lose their home to foreclosure. 

For most people, owning a home is their best chance to achieve sustainable economic security.  Losing that home, in many cases, means losing life savings.  Given the size of the subprime market today—nearly a quarter of all loans made this year—this epidemic of foreclosures will have a negative impact on the economy as a whole, with potentially devastating consequences for African-American and Latino communities, who receive the highest share of subprime loans.

Let me be clear that we are talking about the final loss of a home.  Analysts use a variety of ways to measure foreclosures, and often their statistics refer to loans that have started the process of foreclosure, or the number of outstanding foreclosures at a particular time.  In our analysis, we examined over six million home subprime home loans on an annual basis to track those that actually end in foreclosure. 

We also looked at the factors driving loan failures, and it became clear that the subprime market has basically created a recipe for producing foreclosures:

Take the highest-risk loan features, pack them into an adjustable-rate mortgage with a temporary low monthly payment, and then approve loans without considering whether the borrower can afford the loan after the payments increase.

Today about 80 percent of all subprime loans come with adjustable rates.  A majority of these are 2/28 mortgages, known as "exploding ARMs," which begin with a temporary low fixed payment, but then shift to an adjustable rate payment that rises dramatically .  After the introductory low payment ends, the monthly payment on these loans  jumps by 30 to 40%--a significant amount for any family.  In addition, many of these loans come with expensive prepayment penalties—meaning the homeowner must pay thousands of dollars when forced to refinance to avoid the unaffordable high payments.  To top it off, subprime lenders often approve these loans without considering whether the borrower can actually afford the loan when scheduled payment increases occur or even documenting the amount of the borrower's income.

All of these loan features—adjustable rates, prepayment penalties and limited income documentation—increase the risk of foreclosure significantly.  In fact, our study shows that the risk on an ARM versus a fixed-rate mortgage is 72% higher.  That's an increased risk regardless of the borrower's credit.

Some lenders like to justify risky loans by touting the subprime market's contributions to homeownership, but in fact the majority of subprime mortgages are refinances.  To the extent that the subprime market is offering loans for buying homes, our study shows that subprime purchase loans  have an even greater chance of failing than refinances.  

To make matters worse, subprime lenders often benefit when people get in trouble on their loans, because if there's any equity left in the home, they can offer to refinance the loan again.  In those situations, our research shows that homeowners who end up with multiple subprime refinances run an even higher risk of foreclosure, up to 36%.

There is nothing inevitable or necessary about this high rate of foreclosures on subprime loans; it doesn't need to happen.  In our report, we offer several straightforward solutions for reducing home losses in the subprime market—in our short time, let me emphasize two: 

First, basic protections that are available to most borrowers in the prime mortgage market should also be available to borrowers in the subprime market.  Federal and state banking regulators recently issued Guidance for mitigating risk on non-traditional loans, and that guidance should be extended to cover subprime loans, including exploding ARMs. 

Second, it is unconscionable to sell a loan without verifying that the borrower has no reasonable chance to meet the payments required by the loan.  If we are to achieve sustainable homeownership in the subprime market, lenders—who market themselves as experts—must not approve home loans without establishing that the borrower can meet the payments, including expected increases in payments.

There are more recommendations in the report, and much more information on our study and its findings.  I hope you'll take time to read it, and I look forward to your questions. 

For more information: Kathleen Day at(202) 349-1871 or kathleen.day@responsiblelending.org; Sharon Reuss at (919) 313-8527 or sharon.reuss@responsiblelending.org; or Ginna Green at (510) 379-5513 or ginna.green@responsiblelending.org.

###

About the Center for Responsible Lending

The Center for Responsible Lending is a nonprofit, nonpartisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices. CRL is affiliated with Self-Help, one of the nation's largest community development financial institutions.