A new safer subprime?

Shutterstock.com

Article Highlights

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

    Tweet This

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

    Tweet This

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

    Tweet This

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

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Edward J.
Pinto

What's new on AEI

We still don't know how many people Obamacare enrolled
image The war on invisible poverty
image Cutting fat from the budget
image Speaker of the House John Boehner on resetting America’s economic foundation
AEI on Facebook
Events Calendar
  • 22
    MON
  • 23
    TUE
  • 24
    WED
  • 25
    THU
  • 26
    FRI
Monday, September 22, 2014 | 2:30 p.m. – 4:00 p.m.
Policy implications of the new US labor market normal

We welcome you to join us as a panel of economists discuss US wage and price prospects in the coming months and the implications for the Federal Reserve’s current unorthodox monetary policy.

No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.