Risky Borrowers or Risky Mortgages? Lei Ding, Roberto G. Quercia, Janneke Ratcliffe Center for Community Capital, University of North Carolina, Chapel Hill, USA Wei Li Center for Responsible Lending, Durham, NC, USA September 13, 2008
Community reinvestment type products are mostly FRM with flexible but carefully underwritten standards. Lenders’ knowledge of their community important. Limited due to liquidity concerns.
Starting in the late 1990s:
Subprime loans are products characterized by risky underwriting—reliance on rapid appreciation, low doc or no-doc, low-down or no-down, high debt ratios, originated by brokers.
Starting in the late 2000s:
FHA loans has gained market share after the inset of the current crisis (~30% of originations in 2008?)
Performance of Community Lending is to Prime FRM Subprime Products have the worse Performance Source: Mortgage Bankers Association and Self-Help. 90+day delinquencies include loans in different foreclosure stages. N=44,973 for the CAP portfolio. Sub ARM Sub FRM FHA prime_arm Community Lending Prime FRM
Borrowers holding subprime loans are generally weaker across key underwriting criteria: collateral (down payment), credit history (credit score), and repayment capacity (debt ratios). Yet, many of these borrowers qualify for a prime mortgage (Freddie Mac 2005)
Subprime loans have features found to significantly add to risk
adjustable rates (Calhoun and Deng, 2002)
prepayment penalties and balloon payments (Quercia, Stegman, and Davis, 2007; Danis and Pennington-Cross, 2005)
hybrid ARMs (Ambrose, LaCour-Little, and Huszar, 2005; Pennington-Cross and Ho, 2006)
It is difficult to isolate the impact of loan features unless we are comparing borrowers with similar risk characteristics.
This study compares the relative risk of loan products in a community lending program (Community Advantage Program) and a sample of subprime loans from a proprietary dataset (McDash Analytics) for similar borrowers.
Propensity Score Match: focusing on borrowers with similar risk characteristics but holding different products: CAP or subprime
CAP Subprime Prime Loans Subprime Loans Prime Borrowers Subprime Borrowers
Matched Sample – Subprime Loans Do Worse Predicted Serious Delinquency 24 Months after Origination Note: Estimation is based on a borrower with a FICO score between 580-620 with the mean value of other regressors. Controlling variables include borrower DTI, FICO_score, home equity, loan age, loan size, area credit risk, area unemployment rate, and interest rate environment.
Predicted Serious Delinquency 24 months after Origination Community Lending (CAP) and Retail Subprime loans Note: Estimation is based on a borrower with a FICO score between 580-620 with the mean value of other regressors. sub_arm represents retail originated subprime ARMs without prepayment penalties; sub_arm&ppp represents retail originated subprime ARMs with prepayment penalties.
Predicted Serious Delinquency 24 Months After Origination Community Lending and Broker Originated Subprime Loans Note: Estimation is based on a borrower with a FICO score between 580-620 with the mean value of other regressors. sub_bro&ppp and sub_bro represent broker-originated subprime FRMs with and without prepayment penalties respectively; sub_bro&arm&ppp and sub_bro&arm represent broker-originated subprimeARMs with and without prepayment penalties respectively.
For similar borrowers, subprime loans, ARMs, loans with prepayment penalties, and loans originated by brokers have significantly higher risks than community lending loans
So it is risky borrowers or reckless lenders? The study suggest that the latter plays the central role.
Subprime crisis have us believing that homeownership may be a bad idea for low income households. This is not the case. Done right, done responsibly, low-income homeownership can still be a viable and sustainable asset building tool.