Subprime Mortgage Lending Market

Road Map  What Is Subprime?  A Brief History  How Does the Subprime Market Work?  How Does The Subprime Market Differ From the Prime Market?  Why Subprime Mortgages?  Subprime Crisis

What Is Subprime?  Prime: Ideal Candidates; Lowest Rate  Subprime: Less than Ideal  Limited debt experience  No possession of assets for Collateral  Excessive debt  History of late or missed payments  Defaulting on Debt  Bankruptcy

History -DIDMCA  Depository Institutions Deregulation and Monetary Control Act (DIDMCA)  1980  Deregulated fees and interest rates

History -AMTPA  The Alternative Mortgage Transaction Parity Act (AMTPA)  1982  Variable Interest Rates and Balloon Payments

History -TRA  Tax Reform Act  1986  Increased the demand for mortgage debt  Prohibited the deduction of interest on consumer loans  Allowed interest deductions on mortgages (This made even high-cost mortgage debt cheaper than consumer debt for many homeowners)

Subprime Borrower Subprime Lender Proceeds for new loan Investment Bank Mortgage Backed Securities

Cautions of Subprime  Predatory Lending  High Rates  Hidden costs  Adjustable/variable rates  Over-value Home  Potentially Discriminatory

Protecting the Lender  Not Strictly Predatory  High Risk borrowers  Transfer/Mitigate Risk  Higher Returns

Subprime Differs From Prime  Higher Upfront Costs:  Application fees  Appraisal fees  Higher Continuing Costs:  Mortgage Insurance Payments  Principle and Interest Payments  Late Fees and Fines

Subprime Market  Higher risk –six times as likely to default  Subprime ARMs were only 6.8% of USA mortgages in 2007, but accounted for 43% of the foreclosures

Why Subprime  Borrower:  They want to Buy Stuff  Lender:  Higher Returns  Able to break into the market  3 rd party: some economists; the government.  Homeownership is considered good.  Boom In building market

Subprime Crisis  Prime and Subprime mixed  2006 housing bust  Adjustable Rate Mortgages -80%  Record defaults -underwater  Lost investor confidence in ‘safe’ loans

Questions?

Sources  rtgage_crisisInvestopedia  ‘The Evolution of the Subprime Mortgage Market’ Federal Reserve Bank of St. Louis Review: Jan/Feb 2006  dyn/content/graphic/2007/03/14/GR html  ding