Eric Rosengren describes a “subprime” loan as one that is simply at a higher risk of default, often due to the borrower’s credit history.
The president and chief executive officer of the Federal Reserve Bank of Boston offered that definition to Massachusetts housing, business and public policy leaders at a packed breakfast meeting sponsored by the Massachusetts Institute for a New Commonwealth (MassINC) last Monday.
But many subprime borrowers have credit characteristics that would qualify them for less-risky and less expensive loans, according to Rosengren – and if they don’t, subprime lenders can lessen the likelihood they will default by extending the loans’ “teaser” rate periods.
“Many lenders will actually not be worse off with a term extension,” he told the group, because most already expected the loans would be off their books within two to three years. Typical subprime teaser rates actually “weren’t that much of a tease,” Rosengren noted, since they started at an interest rate of around 8 percent. Resets typically bring the rate up to 11 percent.
So-called 2/28 and 3/27 subprime ARMs already have higher delinquency rates than other types of subprime, adjustable-rate loans, which are themselves the most likely type of loan to default, according to a study the Boston Fed also released last Monday. The study, “Subprime Outcomes: Risky Mortgages, Homeownership Experiences and Foreclosures,” used data from Banker & Tradesman’s parent company, The Warren Group. Available online at www.bos.frb.org, it found that 12.4 percent of subprime adjustable-rate loans in the nation are “seriously delinquent” and further predicted that the rate will rise as long as housing prices continue to drop.
Rosengren said that if more lenders would offer Federal Housing Administration-backed loans and extend rescue-type programs to others besides predatory lending victims, some delinquencies and foreclosures could be headed off.
More than half (55 percent) of 2.2 million U.S. adjustable-rate borrowers have not missed a payment in the past year, the Federal Reserve study found.
That would make them eligible for an FHA-backed loan, since the U.S. Department of Housing and Urban Development-administered agency does not require a minimum credit score, but does look for no missed payments in the last six to 12 months.
Use of the FHA loan program – which is geared toward people with lower incomes, fewer assets or lower credit scores – has gone down steadily in the United States, the Boston Fed study found. In 2000, the federal government agency backed 16 percent of all loans originated nationally, while in 2006 it backed just 2.8 percent.
Those years roughly coincide with increases in subprime loans, which target borrowers with similar characteristics but require less documentation and time to close. Some lenders, Realtors and mortgage brokers came to prefer the faster turnaround time – and higher interest rate and fee structure – the loans entailed.
Borrowers also benefited. Eighty-seven percent of subprime adjustable-rate borrowers nationally are not seriously delinquent, the Fed study found. Many of them might not have been able to own a home otherwise, Massachusetts mortgage trade group officials pointed out at public hearings earlier this year.
‘Simply Not Enough’
But not everyone agrees the cost was worth it.
“The goal of extending homeownership to as many people as possible was noble, but unrealistic. Effortless access to home financing without regard to the cost or consequences is not an acceptable method for helping low- and moderate-income individuals become homeowners,” Thomas R. Gleason, executive director of the state-backed affordable loan provider MassHousing, wrote in his Banker & Tradesman Advisory Board column last week.
FHA-backed loans also are harder to take advantage of in states with high housing costs such as Massachusetts, because the agency will not insure loans greater than $363,000 for a single-family home or $461,000 for a multifamily property.
“The top five FHA lenders are not New England-based institutions,” noted Rosengren, adding that when he asked 60 Middlesex County bankers at a meeting last month how many of them offered the loans, just three said “yes.”
Rosengren said many subprime borrowers have better credit profiles than might be expected, given the type of loan they have.
Twenty percent nationally had loan-to-value ratios of below 90 percent – considered “favorable” – when their loans originated, in addition to presenting fully documented income and assets and credit scores over 620, which is many lenders’ cut-off for prime-rate loans, the Boston Fed study found.
Half the borrowers of all securitized subprime mortgages nationally, and 71 percent in New England, had Fair Isaac & Co. (FICO) scores above 620, it further found.
“Borrowers in subprime loans may need to find new lenders,” especially since eight of Massachusetts’ 10 largest subprime “specialist” lenders have closed their doors in the past year, Rosengren noted. But the situation may not be so hard for all of them.
David Wluka, 2006 board president of the Massachusetts Association of Realtors and of his own development consulting company in Sharon, attended Rosengren’s talk and said his own recipe to help people in trouble on their mortgage loans would include directing them first to their telephone, to call the lender.
Usually, he said, lenders can help to some degree.
Wluka said he thinks the FHA will be a great way to help subprime borrowers in trouble, particularly if proposals by U.S. Rep. Barney Frank, D-Mass., to streamline the paperwork and raise the loan limit – to as high as $500,000 in the nation’s priciest markets – become law. Frank is chairman of the U.S. House Financial Services Committee.
On Dec. 6, President Bush announced a separate agreement between mortgage lenders, Wall Street investors and the White House to help subprime borrowers who could face trouble when their loans reset. Lenders agreed to freeze resets for still-current borrowers on adjustable-rate subprime loans originated between 2005 and July 30, 2007 (with resets scheduled between Jan. 1, 2008, and July 2010), for up to five years.
The freeze “will certainly help people get their acts together,” Wluka predicted. But not everyone agrees.
Boston Mayor Thomas Menino released a prepared statement saying such a move is “simply not enough.”
“An astounding 80 percent of the city of Boston’s foreclosure prevention clients in adjustable-rate mortgages never even made it to the first rate reset,” he said. “I hope that Congress understands that solving the nation’s foreclosure problems is going to take a lot more than a little tweaking around the edges of the mortgage industry.”
Federal Deposit Insurance Corp. Director Sheila Bair first suggested in October that lenders permanently freeze interest rates on a large scale, according to multiple news reports at the time.
Bair cited a report by Moody’s Investor Services that loan servicers had modified less than 1 percent of troubled subprime loans as evidence that lenders weren’t moving fast enough to prevent foreclosures, Inman News Service reported.
