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Cascade: No. 70, Winter 2009

Message from the Community Affairs Officer

Who are subprime borrowers? What are subprime loans? Recently, researchers at the Fed published a paper that provides answers to these questions by looking at a national database of subprime loans.

Researchers Scott Frame, Andreas Lehnert, and Ned Prescott focus on the subprime portion of the market because it accounts for 53 percent of all loans in foreclosure, although it comprises only 12 percent of all firstlien mortgages. The paper, entitled “A Snapshot of Mortgage Conditions with an Emphasis on Subprime Mortgage Performance,” looks at the size of the mortgage industry and how the subprime market is different from the prime market. The data are derived mostly from the Mortgage Bankers Association and a First American Loan- Performance database of securitized subprime loans.

If you haven’t got the time to read the paper, let me help you with some of the pertinent points. The total mortgage market is estimated at 54.7 million first-lien mortgage loans with a combined value of $10.1 trillion. There are about 42.7 million prime and nearprime loans totaling $8.2 trillion and 6.7 million subprime loans totaling $1.2 trillion. Government loans, which are not discussed in the paper, represent roughly 10 percent of the total mortgage market.

Despite their small number and value within the total market, subprime loans, particularly those with adjustable interest rates, are the most problematic. As of the first quarter of 2008, the serious delinquency rate (90 days or more past due or in the foreclosure stage) for subprime loans had increased to 24.11 percent for ARMs and 8.73 percent for fixed-rate loans. These delinquency figures are more than four times higher than for prime ARMs and eight times higher than for fixed-rate prime loans.

Subprime borrowers and loans differ from their prime counterparts in a number of ways.

  • The average FICO scores of prime loans in Fannie Mae and Freddie Mac portfolios are 721 and 723, respectively, but the average FICO score for subprime borrowers is 621, almost 100 points lower.
  • More than three-quarters of prime and near-prime loans have fixed interest rates, but only 48 percent of subprime loans have fixed rates.
  • Both Fannie Mae and Freddie Mac portfolios, which comprise mainly prime loans, have average loan to value ratios (LTVs) of 71 and 73 percent, respectively. However, almost 36 percent of subprime loans have LTVs greater than 90 percent and more than 43 percent of subprime ARMs have LTVs in excess of 90 percent.
  • The average loan size is $202,000 for prime and near-prime loans and $177,000 for subprime loans, but for both subprime and prime loans, the average ARM is 50 to 80 percent larger, respectively, than for a fixed-rate loan.
  • The data show that 22.3 percent of subprime borrowers have second liens, 72.6 percent have prepayment penalties, and the average length of the prepayment penalty term is 30 months.

The authors examine which factors played a role in the performance of subprime mortgage loans. They argue that declining house prices affected the ability of homeowners to refinance or sell, particularly in geographies where there was a big increase followed by a drop in housing prices or where there were poor underlying economic conditions. The problem was made worse because loan-to-value ratios on these loans were higher than they were in the past. Furthermore, the inability to refinance or sell due to declining house prices was a particular problem for subprime ARMs that adjusted in 2007 because the index used to reset subprime ARM rates was particularly high that year.

The authors close with a graph showing how the proportion of owner’s equity as a percentage of household real estate has declined during the past 50 years.

I encourage you to take a look at this interesting study, which is available at www.philadelphiafed.org/foreclosure External Link.

Note: These graphs are figures 8 and 15 in the study.Note: These graphs are figures 8 and 15 in the study.

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