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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About the Author

 

Edward J.
Pinto
  • American Enterprise Institute (AEI) resident fellow Edward J. Pinto is the codirector of AEI’s International Center on Housing Risk. He is currently researching policy options for rebuilding the US housing finance sector and specializes in the effect of government housing policies on mortgages, foreclosures, and on the availability of affordable housing for working-class families. Pinto writes AEI’s monthly Housing Risk Watch, which has replaced AEI’s FHA Watch. Along with AEI resident scholar Stephen Oliner, Pinto is the creator and developer of the AEI Pinto-Oliner Mortgage Risk, Collateral Risk, and Capital Adequacy Indexes.


    An executive vice president and chief credit officer for Fannie Mae until the late 1980s, Pinto has done groundbreaking research on the role of federal housing policy in the 2008 mortgage and financial crisis. Pinto’s work on the Government Mortgage Complex includes seminal research papers submitted to the Financial Crisis Inquiry Commission: “Government Housing Policies in the Lead-up to the Financial Crisis” and “Triggers of the Financial Crisis.” In December 2012, he completed a study of 2.4 million Federal Housing Administration (FHA)–insured loans and found that FHA policies have resulted in a high proportion of working-class families losing their homes.

    Pinto has a J.D. from Indiana University Maurer School of Law and a B.A. from the University of Illinois at Urbana-Champaign.

  • Phone: 240-423-2848
    Email: edward.pinto@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: 202-419-5212
    Email: emily.rapp@aei.org

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