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1.4.1 Market Overview

Loans in the mortgage market can be lumped generally into three categories: prime, subprime, and predatory. The lines between categories are blurry, and the share of each market as a percent of the mortgage market as a whole has varied over time. Though market share of subprime and predatory loans waxes and wanes, an understanding of these markets is essential for advocates defending foreclosures.

Many Americans in the middle- and upper-economic classes receive competitive interest rates and pay few fees to buy homes, refinance their mortgages, purchase cars and other consumer goods, take vacations, repair their homes, and send their children to college. The “prime” or “conventional” lending market serves these homeowners. In this market, consumers qualify for the best rate offered by the lender. Originators in the prime market may allow borrowers to buy down the rate offered by paying points in cash or financed as part of the loan.54 Originators may also permit the borrower to opt for a higher interest rate rather than pay points or closing costs at the closing.

The prime market serves “A” borrowers with credit scores typically greater than 650.55 Prime borrowers can access fixed or adjustable long- and short-term mortgage loans to purchase or refinance a home and home equity lines of credit or second mortgages for repairs or other expenses. Underwriting standards are fairly uniform, thanks in large part to Fannie Mae and Freddie Mac.56

For those whose credit is blemished to any degree and others who are steered to unconventional lenders, the “subprime” mortgage market can be a very different experience. The subprime market provides credit for “A- to D” borrowers with FICO scores under 650–670. “Alt A” (low or no document loans) may be considered subprime loans even though the FICO scores of the borrowers may be similar to their prime counterparts.57 The subprime market also makes high loan-to-value (LTV) loans, even where the borrower has relatively good credit.58

The subprime market has been characterized by a sliding scale of interest rates based, in part, upon credit risk. Interest rates have run from several percentage points above to almost double the rates offered prime borrowers.59

In addition, subprime lenders usually charge higher points and fees than their prime counterparts, and include prepayment penalties more often. A 2004 study showed that about eighty percent of subprime loans contain prepayment penalties, compared with only two percent of loans in the competitive prime market.60 Prepayment penalties are especially onerous for this group, since the penalty deters them from refinancing into a prime loan.

The predatory market generally exists as a subset of the subprime market.61 In this market, price may have more to do with gouging than with risk.62 There is no single definition for predatory lending, and due to the lack of publicly reported data on this market, it is difficult to quantify the number of predatory loans or the percentage of the subprime market that they represent. One industry-commissioned study found that the 12.4% of first lien loans and 49.6% of second lien loans made by nine lenders between July 1, 1995, and June 30, 2000, were high-cost loans as defined by the federal Home Ownership and Equity Protection Act.63 These loans are extraordinarily expensive because they either have annual percentage rates of at least ten percent above comparable treasury securities or the points and fees exceed eight percent of the total loan amount.64 In addition, an independent researcher estimated that twenty-one percent of loans in certain areas of Philadelphia were predatory.65In Montgomery County, Ohio, an independent study of a random sample of mortgage loans associated with foreclosures revealed that twenty-one percent were predatory.66

Footnotes

  • 54 {54} One point equals one percent of the principal.

  • 55 {55} U.S. Department of the Treasury and U.S. Department of Housing and Urban Development, Joint Report on Recommendations to Curb Predatory Mortgage Lending 33 (2000), available at www.huduser.org/publications/hsgfin/curbing.html; Alan M. White, Risk-Based Mortgage Pricing: Present and Future Research, Housing Policy Debate vol. 15, no. 3, at 509 (2004).

  • 56 {56} Kenneth Temkin, Jennifer E. H. Johnson, Diane Levy, U.S. Dep’t of Housing and Urban Dev., Office of Policy Development and Research, Subprime Markets, the Role of GSEs, and Risk-Based Pricing, Report Prepared by the Urban Institute 21 (2002); U.S. Department of the Treasury and U.S. Department of Housing and Urban Development, Joint Report on Recommendations to Curb Predatory Mortgage Lending 33 (2000), available at www.huduser.org/publications/hsgfin/curbing.html.

  • 57 {57} Kenneth Temkin, Jennifer E. H. Johnson, Diane Levy, U.S. Dep’t of Housing and Urban Development, Office of Policy Development and Research, Subprime Markets, the Role of GSEs, and Risk-Based Pricing, Report Prepared by the Urban Institute 21 (2002).

  • 58 {58} Loan-to-value ratio (LTV) is the relationship, expressed as a percentage, between the loan amount and the value of the property securing the loan.

  • 59 {59} See Federal Reserve Board at www.federalreserve.gov/releases/h15/data.htm (for historical rates on conventional mortgages); Alan M. White, Risk-Based Mortgage Pricing—Present and Future Research, Housing Policy Debate 15:3 (2004).

  • 60 {60} John Farris & Christopher A. Richardson, The Geography of Subprime Mortgage Prepayment Penalty Patterns, Housing Policy Debate 15:3, at 688 (2004). See also U.S. Department of the Treasury and U.S. Department of Housing and Urban Development, Joint Report on Recommendations to Curb Predatory Mortgage Lending 93 (Washington, D.C. 2000) (showing a 70% rate for subprime loans and a 2% rate for prime loans); Ellen Schloemer, Wei Li, Keith Ernst & Kathleen Keest, Ctr. for Responsible Lending, Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners (showing incidence of prepayment penalties in subprime loans ranging from 54.37% to 71.70% from 1998 to 2005).

  • 61 {61} Prime loans could be predatory, though the likelihood is much smaller in that market.

  • 62 {62} Alan M. White, Risk-Based Mortgage Pricing—Present and Future Research, Housing Policy Debate 15:3, at 503 (2004).

  • 63 {63} Michael E. Staten and Gregory Elliehausen, Credit Research Center, The Impact of the Federal Reserve Board’s Proposed Revisions to HOEPA on the Number and Characteristics of HOEPA Loans (2001).

  • 64 {64} 15 U.S.C. § 1602(aa).

    The Federal Reserve Board lowered the APR trigger in 2002 to 8% above comparable treasury securities for first lien mortgages. The spread for subordinate lien loans remained at 10%. 66 Fed. Reg. 65,604 (Dec. 20, 2001) (effective Oct. 1, 2002).

  • 65 {65} Ira Goldstein, Reinvestment Fund, Predatory Lending: An Approach to Identify and Understand Predatory Lending (2002).

  • 66 {66} Richard Stock, Center for Business and Economic Growth, Predation in the Sub-Prime Lending Market: Montgomery County (2001).

    Note that the definitions of predatory lending varied between the Dayton and Philadelphia two studies. In the Goldstein study, predatory lending was defined through the use of property lien data to mean the flipping of mortgage loans resulting in the increasingly larger first liens placed on the properties. Stock examined interest rate, fixed versus adjustable rates, balloon payments, waiver of jury trial, prepayment penalties, excessive fees, and the inclusion of single premium life insurance. In another study, researchers in North Carolina found that subprime loans with features defined as predatory, i.e., prepayment penalties with terms of three years or greater, balloon payments, and loans with combined LTVs of at least 110%, declined in North Carolina after the enactment of an anti-predatory mortgage lending law. Forberto G. Quercia, Michael A. Stegman, & Walter R. Davis, Assessing the Impact of North Carolina’s Anti-Predatory Lending Law, Housing Policy Debate 15:3, at 593–594 (2004).