A new safer subprime?

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Article Highlights

  • The new "safer" subprime loan would have an expected 25%-30% default rate under a 2007 economic stress event.

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  • Under anyone's definition, a 25%-30% default rate would not be considered safe.

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  • Low-income and minority borrowers have suffered disproportionately from subprime lending.

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Recently Bloomberg ran a story entitled: “Subprime Called Safer Makes Comeback as ‘Nonprime’: Mortgages.”  The article  described a new “safer” subprime loan with a credit score of 550 to 599, 30 percent down, and full-documentation.   The problem is this “safer” subprime would have an expected 25%-30% default rate under a 2007 economic stress event.   Yes this is an improvement over the old “unsafe” ARM subprime loan from 2006 which had about a 45% default rate.  However, under anyone’s definition, a 25%-30% default rate would not be considered very safe.

FHA, the government’s subprime alternative, will insure loans with a FICO score as low as 580 and a down payment as low as 3.5%.  While these loans generally meet the definition of a qualified mortgage, they have an even higher expected stress default rate of 35%-40%.

Low-income and minority borrowers have suffered disproportionately from subprime lending.  This has taken the form of high rates of default and foreclosure, neighborhood blight, and extreme home price volatility. Martin Luther King Jr. recognized the problem living beyond their means caused for working-class families:

    “Now the economists also say that your house shouldn’t cost—if you’re buying a house, it shouldn’t cost more than twice your income. That’s based on the economy and how you would make ends meet. So, if you have an income of five thousand dollars, it’s kind of difficult in this society. But say it’s a family with an income of ten thousand dollars, the house shouldn’t cost much more than twenty thousand. Well, I’ve seen folk making ten thousand dollars, living in a forty- and fifty-thousand-dollar house. And you know they just barely make it. They get a check every month somewhere, and they owe all of that out before it comes in. Never have anything to put away for rainy days.”

-Martin Luther King Jr. “The Drum Major Instinct” sermon, Atlanta, GA, February 4, 1968.

Edward J. Pinto is a Codirector of AEI's International Center on Housing Risk

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