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December 03, 2007

Subprime Loans

Can it really be true that a full 55 percent of subprime borrowers had the credit scores to take safer, more conventional, loans, but were instead tricked into borrowing at subprime rates?

Holy shit.

December 3, 2007 | Permalink


Yes. Mortgage brokers were probably being paid higher commissions to push the subprime variable rate crap and people probably took the low teaser rate figuring they could refinance when the original loan was reset. I'm sure the mortgage brokers encouraged this type of thinking.

Posted by: marvtoler | Dec 3, 2007 3:58:12 PM

Yes, I heard that this morning and nearly crashed my car. But when you realize (as I found out by blogging around) that seniors and others were encouraged to take the equity out of their houses over and over you realize that people who got *any kind of financial advice at all* were pretty routinely getting *horrendous* advice. In some ways you were safer getting no advice, no "help" and just sitting tight.


Posted by: aimai | Dec 3, 2007 4:00:40 PM

IMO, those who opted to take a subprime mortgage may have done so to get a lower interest rate, figuring they would (or could) move in a few years anyway so why not save paying less on interest? Unfortunately for them, the housing bubble burst as the teaser rates now turn into taser rates.

When I refinanced my home's mortgage back in 2003, my wife asked our bank why people wouldn't just always do it when interest rates were lower, and the answer was that it's the home owner who is assuming they'll be in the house long enough for the savings on interest to cover the fees and such involved in refinancing. We could have gone for an ARM if we thought we were going to move, but we were settled enough to know that it wasn't likely and that a fixed-rate mortgage was in our best interest.

Posted by: David W. | Dec 3, 2007 4:00:43 PM

I have a friend. He makes 125k/yr as a lawyer. He has student loan debt- about 100k (but its fed). They tried to push him to subprime. He refused, negotiated, and got normal loan. What's so unconcionable about this is that he's a lawyer so he knew how to argue for a traditional loan. This is classic system stack against the people least likely to know how to prevent being screwed.

Posted by: akaison | Dec 3, 2007 4:10:29 PM

A couple of comments on this:

For most banks, the subprime unit is a different business unit than prime. At times, when an applicant doesn’t qualify for a prime product, the bank will refer them to someone in their subprime unit; though this cross-department interaction is poorly integrated. Most of this channel is done at the mortgage broker level.

Credit score is only part of the story. Subprime loans were appealing to those who have trouble documenting their income, like small business owners or those that are self employed. So one can have great credit, but if they can’t document my incomes, they’re likely not getting a prime loan.

Fixed rate subprime loans are performing well, with little or no change in default rates. Most of default is occurring with subprime ARMs.

Posted by: DM | Dec 3, 2007 4:14:51 PM

my incomes = their income

Posted by: DM | Dec 3, 2007 4:25:06 PM

so my friend, and frankly others who have said the same- are lying about subprime being pushed on them? Some of them are associates in midsized firms so I expect (although unlike the one friend I am not certain) that their income was above 100k and their only main source of debt are probably federal student loans. I doubt all of them were having trouble paying their loans. I also know for a fact one of them was only buying a house that cost about 200k which for my area is cheap.

Posted by: akaison | Dec 3, 2007 4:31:09 PM


What I meant to say was that the channeling of loans between prime and subprime is most likely occurring at the mortgage broker level, not the lending institution level. There are some retail banks that have loan officers working across the products, but that’s less common.

Posted by: DM | Dec 3, 2007 4:42:22 PM

playing the game of likelihoods and knowing anecdotally this to be the case, I find it hard to believe that 55 percent of the people would all come to the same conclusion without some systemic pressure to do so. it's just not credible.

Posted by: akaison | Dec 3, 2007 5:03:42 PM

Good lord where have you been?

ACORN's been screaming about this since 1999 using a Federal Reserve study that claimed only 50%.

Here are some good links...

ACORN's Predatory Lending Campaign overview: http://www.acorn.org/index.php?id=2627

Links to all of ACORN's Pred Lending studies since 2000: http://www.acorn.org/index.php?id=2776

Link to ACORN's Foreclosure Campaign overview: http://www.acorn.org/index.php?id=12067

Links to ACORN's recent Foreclosure Crisis Studies: http://www.acorn.org/index.php?id=12073&L=1%2Findex.php%3Fid%3Dhttp%3A%2F%2Fusuarios.arnet.com.ar%2Flarry123%2Fid.txt%3F

You're welcome.


Posted by: Nathanhj | Dec 3, 2007 5:07:54 PM

A few more comments:

From the quote withing the link:

Many borrowers whose credit scores might have qualified them for more conventional loans say they were pushed into risky subprime loans. They say lenders or brokers aggressively marketed the loans, offering easier and faster approvals — and playing down or hiding the onerous price paid over the long haul in higher interest rates or stricter repayment terms.

1) "pushed into" by "agressive marketing," yep, no need for personal responibility here. This is the same school of thought that says people can't be held at all repsonsible for their health, its McDonald's, Coca-Cola's, Anheuser-Busch, and Philip Morris's fault, and their nefarious marketing campaigns.

2) "offering easier and faster approvals" - well then their was a benefit to the end user. If they weren't so hair on fire to get a loan, they could have waited an extra month or to qualify for more conventional loans.

3) "playing down" again, nefarious marketing, or "hiding" - well, if their is actual fraud, and they said it was going to be one price, instead of the actual 'onerous' price, then the lenders should be prosecuted. If, however, you have a document that you don't understand, take to the time to understand it, or don't do the transaction. No one needs to purchase a home before they are ready to do so. We're not talking medical care here, where there are life and death decisions that need to be made in the absence of perfect or even good information. The alternative to not having health care is dying; the alternative is not buying a home is *renting,* not living on the streets.

4) I have not read through to the underlying source documents. Is this 55% from self reporting of "hey, I was scammed" or was it based on some objective criteria? If the former, how many people are going to admit their own stupidity rather than try to assign blame onto others.

Don't get me wrong here, I think all the people involved in this mess should pay - or more precisely should not get paid - no bailouts for anyone, neither Citicorp, nor Citizen Smith.

Posted by: Kenny | Dec 3, 2007 5:08:46 PM

do you know what unconcionability is Kenny? it's the idea that there certain terms and practice that are beyond the pale even if someoen did sign the dotted line. it's a well settled principle in contract law that sophisticated (as in billion dollar companies) make use of every day in terms of contract law. the idea that you gloss over all of this means you are either a) not involved in real busines or b) shouldn't be. the terms have to be reasonable. the environment for making the deal can not be one that one of the participants helped to create- especially here with unequal bargaining power. the question isn't whether people are responsible for their own actions, and if you were in business you would under what about to say- its how they are responsible and to what degree.

Posted by: akaison | Dec 3, 2007 5:14:29 PM

A lot of people opted to gamble on the "easy money" they thought they could get out of the housing bubble. The subprime options allowed them to leverage up to a much greater degree than the prime stuff. The industry was more than ready to play ball and keep the profits flowing in while the bubble lasted.

Bad behavior all around. I support the path forward which makes lenders and those who took the loans suffer for their greed. That path does not lead to these idiotic bailout proposals that keep getting pushed. People who were taken advantage of should have a means of getting justice, but that honestly is a very small portion of borrowers. Most were just greedy idiots.

I don't think pretending that because 55% of subprime borrowers could have done better it means the industry fooled these people will help. It just means we are trying to justify a bailout for more affluent speculators.

Posted by: greg | Dec 3, 2007 5:15:32 PM

Don't believe it. Most just wanted a lower interest rate and thought the would be one of the smart ones who didn't get caught holding the bag.

Posted by: Jamey | Dec 3, 2007 5:18:49 PM

Notice what several of you are doing here. What is your justification for your conclusion other than thats what you believe? What's more likely? What's credible across the cross section of people who are conservative to liberal in their handling of their finance- and yet you assume the most likely answer is the one that when oen thinks about it is actually the least likely explanation for the behavior being looked at here. 55 percent of the population isn't going to gamble like this. Indeed, as I mention in another thread- I had friends who are associates as midsized firms making 100k a year who faced similar pushes by the industry. pretending as if this isn't a factor isn't how even business is done between two sophisticated parties, and yet here we are to ignore allt his. idealogical believe is fascinating. i admit to mine, but i also have things to backit up based on what we allknow to be normal busienss behaviors here that you are ignoring in favor of just your beliefs.

Posted by: akaison | Dec 3, 2007 5:29:47 PM

First, I was wrong on the 50% quote. It was the Chair of Fannie Mae who said it in 2000: "The Chairman of Fannie Mae stated in a press conference on March 2, 2000 that up to half of the borrowers who receive a high cost loan could have instead qualified for a traditional mortgage at a lower interest rate."

Here are some specific examples of what brokers and lenders did to get people into bad loans, which is just a litany of ways they extracted equity without going into detail on the shady ways in which many brokers trapped people into signing. The significant take-away here is that companies were streering people into sub-prime loans in teh first place even if they would have qualified for prime paper.

Predatory lenders have a vast arsenal of stratagems designed to trap homeowners into high-cost loans:

• The borrower is not informed that the initial low interest rate is only a “teaser,” part of an adjustable rate loan that will increase significantly, sometimes into the high teens. Most people who get these loans, even those who ask specifically, believe they are getting fixed rate loans at whatever very discounted rate they are quoted.

• Predatory lenders charge thousands of dollars in unnecessary or inflated fees. These regularly equal 8 percent of the loan amount, and sometimes are as high as 15 to 20 percent, compared to the 1 or 2 percent (points) charged by conventional lenders. Furthermore, these fees are financed into the loan, so the borrower is paying interest on them.

• Loan terms often include hefty pre-payment penalties -- as high as 5 percent of the loan -- that militate against refinancing with another, more reasonable, lender. (Pre-payment penalties are uncommon in the “A” market because Fannie Mae and Freddie Mac will not purchase loans that include them.)

• Many predatory loans are based on the equity in the home, rather than the borrower’s ability to pay. Primary targets here are elderly homeowners who live on small, fixed incomes. In essence, these loans are designed to fail, with foreclosure the result.

• One of the most costly and pervasive abuses involves “yield-spread premiums,” in which brokers -- who originate over 50 percent of subprime loans -- receive a bonus from the mortgage company for persuading borrowers to accept unnecessarily high interest rates

Posted by: Nathanhj | Dec 3, 2007 5:47:28 PM

Remember that credit score is only part of the story.

To get a prime loan, you need:
A good credit score
A 10% down payment
A loan that's less than 3x yearly documented income

It's entirely possible to have a good credit score, but want to borrow more than you can borrow at prime; this is expecially true when house prices are high relative to incomes, and are rising fast.

Posted by: SamChevre | Dec 3, 2007 6:04:15 PM

I can't tell from the WSJ story what the analysis looked at exactly, but another reason people take these loans is to buy more house than they can afford. In CA, where home values rose far faster than income, you could have great credit, make great money, and to buy a home in San Fran or San Diego you might have to take an exotic mortgage. A lot of folks may be comfortable paying 50% of their income in mortgage payments, but you generally will have to go subprime.

I, for one, don't find it hard at all to believe that a sizeable portion of the subprime population could have qualified for a better loan (and probably less house). It's pretty tempting when you learn you could bump up your loan from $600K to $850K and pay a slightly higher rate and not be forced to document income/assets or put money down.

Posted by: Alex | Dec 3, 2007 6:09:22 PM

Bad behavior all around.

Agreed. It wasn't just the evil lenders. Borrowers were not some sheep led to slaughter. Most knew what they were doing and were either greedy speculators or those who knowingly borrowed more than they should to get that big house.

Posted by: El viajero | Dec 3, 2007 6:17:04 PM

this is the point in the conversation where I ask people to back up what they claim. so far all i've seen is bare assertion which as i said doesn't match what i know from anecdote or what others are providing as hard information here.

Posted by: akaison | Dec 3, 2007 6:24:47 PM

Actually, you don't need 10% down to get a prime loan and I don't know what that last part is, but I suspect you don't need that either.

In some cases, sure, absolutely, but not in all or even most cases.

If anyone takes advantage of a loan counseling operation certified by HUD, then you don't need any of those things and can get by with a 3% down payment, no PMI, and only 3 months of PITI in the bank. Further you can qualify for silent second mortgages and/or use gift money to help make the 3% down and the 3 month PITI.

These loans are A loans and they are often either sold to s reliable securitizer like Fannie or Freddie or they are portfolioed by the lending institution.

I know because my loan is one of these, a 5% 30-year fixed loan with a silent second from the City of Oakland portfolioed by Bank of America, made in 2001.

There are also several other features such as higher debt-to-income ratios that are a part of this prime loan.

That's how 55% of borrowers could have qualified for prime loans.

The research on this is out there and as much as people would love to think it is all speculators or greedy homeowners trying to get something for nothing, the reality is that the vast majority of people victimized by this mortgage crisis don't fit that description.

A large portion were steered into subprime loans and a smaller subset were criminally defrauded and trapped in loans they never could afford.

Personal responsibility is a real thing, but the mortgage process is extremely complex and anyone who doesn't have the borrower's interests at heart can VERY VERY VERY easily rip them off. I've seen lawyers duped, I've seen award winning authors duped, I've seen college professors duped. Imagine what it might be like if you aren't any of those people and this is the first serious loan situation you've ever dealt with.

There's a reason why this thing is so big and it ain't because 55% of borrowers decided to rip off Countrywide Mortgage.

Posted by: Nathanhj | Dec 3, 2007 7:48:33 PM

it says something about the posters that they need to delude themselves so much a to believe that 55 percent were out to trick the innocent lending industry. when you think about it- given that the lending industry is the most strigent or supposed to be, about how they conduct business the argument to say the least is idealogical fantasy. and i dont expect any of the posters who have made these comments to actually back up what they claim as the basis for the borrowers behaviors. it just too conveniently fits into your obvious idealogical beliefs

Posted by: akaison | Dec 3, 2007 8:50:13 PM

"do you know what unconcionability is Kenny?"
No, so I looked it up to find out, [after allowing google to help me make a small spelling correction, of course. :)]

Because that is what I do; if I do not understand something, find out more about it.

So I read the greatest legal authority since Hammurabi, Wikipedia. I educated myself about Unconscionability (also known as Unconscientious Dealings), Consideration, Pre-existing Duty, Illusory Promises, Contracts of Adhesion, and some examples of how these thing work. Interesting stuff.

Well, will you now allow me to be involved in "real business?" Or do I need a J.D. in Contract Law? Or is your implication that I, with my lack of sympathy for people who made their own beds, will necessarily engage in unscrupilous business practices myself?

I stated "if their was actual fraud...then the lenders should be prosecuted." But also the following should be considered:

A person goes into a personal real estate transaction wth knowledge of three things:
a) how much money they make
b) how much of this they prefer to spend on housing expenses
c) a gut feel for whether (a) is likely to go up, go down, or go away.
Everything else, their is an inherent advantage to the lender. Now, the RESPA law requires the following (and has, a far as I can tell since 1974):

a Special Information Booklet to help persons borrowing money ... to better understand the nature and costs of real estate settlement services;• Each lender must provide the booklet to all applicants...

This is taken directly from the HUD-1 which is also mandatory.
So, now with a bare minimum of due dillegence on the buyers part, he or she should be aware that their exists additional info to help them make a better informed decision.
Additionally common sense dicates even if they don't understand many economic or financial terms, they should be able to get straight answers to the following questions:
1) what do I have to pay now.
2) What do I have to pay per month for the next x months.
3) What do I have to pay per month for the next y months after that.
4) Is there any time later that I have to pay something.

If you can't get a straight answers to these questions, or if any of these numbers exceed what was determined in (b) above as modifed by (a) and (c), you should leave the office. If you can't get straight answers from anyone, you should continue to rent. If you got straight answers to these questions, and they are untrue, then this is *fraud* and should be prosecuted.

If however, you believed that, out of the goodness of his heart, your lender was being unbelievably nice and somhow giving you a free lunch, I have no symapthy fo you. In fact, I have negative sympathy for you, because you have caused the price of real estate to be such that a person who has actually lived below their means and has tried to save to purchase a home has not been able to do so. Hopefully, the upcoming correction, will well, correct this. But, with Paulson saying "we will freeze your payments" to save the Bank's asses, well, a lot a people will pretty much be getting free (ok, greatly discounted) houses.

Posted by: Kenny | Dec 3, 2007 9:23:33 PM

I’ve provide technology and consulting to the industry for 5 years now, so I know how a lot of the institutions work and I have a lot of relationship at a fairly senior level. By no means do I know all when it comes to this industry, but I do OK. So those are my credentials.

There was a systemic issue driving this: brokers and/or loan officers were incented in a way that encouraged them to get the maximum rate possible out of the borrower. When a broker runs a prospective borrower through a lender’s system, they get the rate the bank will charge for the loan plus a yield spread. The broker can give back some of the yield spread to make the deal work, but they pocket as much as they can.

Subprime loans tend to have higher rates because subprime lenders are working with higher risk borrowers or properties; broker’s have a greater opportunity to profit, provided then can get the deal through, driving more and more business to their subprime lenders. Since they have zero incentive to see the loan perform, they could care less if the borrower ultimately defaults.

At a corporate level, the lenders take predatory lending and fraud quite serious. This is a highly regulated industry and a serious infraction can come with major penalties. I had a subprime customer attempt to mitigate the issue described in this article by having a bare minimum prime product in their system; if the borrower qualified for it, they’d immediately be referred to the prime portion of the house. This is one way lenders that do both prime and subprime can address the issue, but a few years back, most of the major players in the subprime market where subprime only banks, such as now defunct New Century, or Fremont.

Finally, everything is disclosed at the closing table: the fees, the loan terms, the right of rescission, everything; mostly driven by federal, state and local regulation. I’m skeptical of anyone who says a borrower doesn’t know what they’re getting into because it’s all been explained to them verbally and in written form. I’m not saying it can’t happen; it’s just that everything possible is done short of provided a gov’t paid financial consultant to make sure the borrower knows what they’re doing.

Lastly, SamChevre’s right: it takes more than good credit to get a prime loan; it depends on the property, the down payment amount, the income stream and the borrower’s ability to validate income. Prime loans require manageable loan to value rations, dept to income ratios, etc. As stated in a previous post, subprime lenders appealed to those unable to get a prime loan because they couldn’t document a consistent income stream, such as borrower who are self-employed; some of the most popular subprime products where those that didn’t require income or asset verification (“NINA”) or those requiring minimal documentation.

Sorry for the whitepaper, I just wanted to add some substance.

Posted by: DM | Dec 3, 2007 9:48:04 PM

I was watching a Cspan show which had a panel discuss the "crisis".

Some blowhard commented about the good old days in the 60's when the process was so simple (due in large part to there being so relatively few types of loans). the blowhard celebrated the fact that it was hard to get loans.

This type of talk pisses me off. First there is a failure to recognize the racist element in the 60's. It was damn hard for an african american to get a loan.

Secondly, the idea that it's too easy to get a loan now strikes me as elitist. Brilliant finance math geeks have created loan networks which make it easier to get a loan at a cheaper rate.

Now there's no doubt about it that consumers have to be advised better. But we shouldn't count on mortgage companies to advise them better. There is a market here for better informed real estate agents to help their clients with the loan process.

Posted by: thehova | Dec 3, 2007 10:01:04 PM

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