Subprime Mortgages: 50 Shades of Risk

New Orleans Long Long AgoSubprime mortgages continue to be the riskiest type of mortgage you can get — and yet things are looking better for both subprime borrowers and subprime lenders.

How can that be?

Subprime mortgages are a form of financing designed for those with impaired credit. That’s a polite term for individuals who have low credit scores, often for reasons beyond their control such as a job loss, the death of a spouse, a divorce or medical expenses. In some cases, however, subprime borrowers have low credit scores for a very simple reason: They don’t pay their damn bills.

Notice that credit scores have nothing to do with income. Fast food workers who make payments on time and in full can have better credit scores than the richest family in town. The great secret of good credit is not how much you owe or how much you make it’s simply how you pay back your debts.

Subprime Mortgages and Fewer Foreclosures

The latest figures from the Mortgage Bankers Association show that subprime mortgages have become very much less risky — a concept which must be seen in context.

First, let’s look at how subprime loans have become less risky.

The MBA says that during the fourth quarter of 2013, the latest available numbers, lenders had started foreclosure proceeding with 1.66 percent of all subprime loans. This is a huge reduction from the first quarter of 2009 when lenders started foreclosures with 4.65 percent of all subprime mortgages. Indeed, the MBA reports that delinquency and foreclosure activity hit a six-year low in late 2013.

Why are there fewer subprime foreclosures today? Many new mortgage regulations under Dodd-Frank went into effect during January 2014 but large numbers of lenders – thinking ahead and wanting to avoid excess risk — started making less risky loans years ago. Their reward can be seen in the lower foreclosure start numbers. No less important, many of the lenders who were the leading suppliers of toxic loans are now out-of-business.

A second reason for fewer foreclosure starts concerns the marketplace in general. As RealtyTrac, the nation’s leading source for comprehensive housing data and listings, explains, “January marked the 40th consecutive month where U.S. foreclosure activity declined on an annual basis.” In fact, foreclosure activity in 2013 was down 18 percent from the year before.

One reason for fewer foreclosures is that the inventory of toxic loans originated between 2000 and 2008 continues to decline. A second reason is that the less-risk standards established under Wall Street reform are paying off.

Subprime Mortgages Remain Risky

That said, subprime loans remain more risky than other forms of financing. Again, using figures from the Mortgage Bankers Association, we can easily see why lenders are extremely cautious when making subprime mortgages, even with higher mortgage rates. The foreclosure start rates for various forms of financing looked like this during the fourth quarter of 2013:

  • Subprime mortgages:  1.66 percent
  • Prime mortgages:          .34 percent
  • FHA mortgages:             .75 percent
  • VA mortgages:                .47 percent
  • All mortgages:                 .54 percent

What these figures show is that even in better times subprime borrowers are nearly five times more likely to face foreclosure than prime borrowers, a pattern which has been fairly consistent for the past five years. The good news is that foreclosure levels in general are falling and that helps borrowers, lenders and mortgage investors.

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