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1.3.4.5 Predatory Loans Created Risk

Higher-priced loans and those containing certain predatory features increased the chance of foreclosure.284 This can be seen by the extraordinary rates of foreclosure for higher-priced loans and how even a small difference in price can lead to large increases in the foreclosure rate. One national survey found that having a subprime loan increased the risk of foreclosure by more than fourteen times.285 Borrowers seventy and older with subprime loans experienced foreclosure at 21.5 times the rate as borrowers of the same age with prime loans.286 Federal Reserve Board research found that every one percent increase in high-cost lending led to a 0.03% increase in the foreclosure rate for the whole metropolitan statistical area, a significant increase.287 The severity of the foreclosure crisis on a state-by-state basis roughly tracks the extent of high-cost mortgage lending in the state.288

Many features of typical subprime loans, including prepayment penalties, balloon payments, low or no documentation, and variable interest rates, particularly in combination, have been shown to increase the risk of foreclosure.289 These effects are independent of, and occur before, any adjustable rate reset, prepayment, or balloon payment due date.290 Thus lenders cannot justify the increased pricing sometimes associated with these products as compensation for their increased risk of default. Rather, the increased pricing is pushing borrowers into default.291

Piggyback loans are another example of subprime products associated with dramatically increased foreclosure risks.292 Piggyback loans are second lien loans used to fund the down payment on a purchase or supplant mortgage insurance on a high loan-to-value refinance loan. Before the foreclosure crisis, the number of piggyback loans that were associated with a high-cost first lien loan dramatically increased, particularly in poor and non-white communities.293 Layering of risky products on high-rate mortgages imposed an increased risk of default.

Footnotes

  • 284 {206} See Ctr. for Cmty. Capital, Community Advantage Panel Study: Good Business and Good Policy: Finding the Right Ways to Serve the Affordable Mortgage Market 6 (2009) (relationship between the market rate and mortgage interest rate is “a leading predictor of default”); Elizabeth Laderman & Carolina Reid, Fed. Reserve Bank of San Francisco, Working Paper No. 2008-5, Lending in Low- and Moderate-Income Neighborhoods in California: The Performance of CRA Lending During the Subprime Meltdown 15 (Nov. 2008), available at www.frbsf.org (higher-priced loans are significantly more likely to be in foreclosure than those not designated as higher-priced in the HMDA data); U.S. Gov’t Accountability Office, Pub. No. GAO 09-741, Home Mortgages: Provisions in a 2007 Mortgage Reform Bill (H.R. 3915) Would Strengthen Borrower Protections, but Views on Their Long-Term Impact Differ 29–30 (2009), available at www.gao.gov (finding a significant increase in the twenty-four-month default rate for a wide variety of subprime products based on the increase in the rate over the comparable index; as this spread increased, so did the rate of default). Cf. Ira J. Goldstein, The Reinvestment Fund, Lost Values: A Study of Predatory Lending in Philadelphia 66 (2007), available at www.trfund.com (subprime lenders accounted for 72% of the loans in foreclosure in Philadelphia between 2000 and 2003).

  • 285 {207} AARP Pub. Pol’y Inst., A First Look at Older Americans and the Mortgage Crisis 5 (2008), available at http://assets.aarp.org.

  • 286 {208} Id.

  • 287 {209} Robert B. Avery, Kenneth P. Brevoort & Glenn B. Canner, The 2006 HMDA Data, Fed. Reserve Bull. A73, A107 (2007), available at www.federalreserve.gov (holding economic factors constant). See AARP Pub. Pol’y Inst., A First Look at Older Americans and the Mortgage Crisis 5 (2008), available at http://assets.aarp.org (having a subprime loan increases the risk of foreclosure on average by 14.4%, and by 17% for Americans over fifty).

  • 288 {210} Office of Pol’y Dev. & Research, U.S. Dep’t of Hous. & Urban Dev., Report to Congress on the Root Causes of the Foreclosure Crisis 9–14 (2010), available at www.huduser.org.

  • 289 {211} See, e.g., id. at 17 (collecting studies); AARP Pub. Pol’y Inst., A First Look at Older Americans and the Mortgage Crisis 6 (2008), available at http://assets.aarp.org (having a loan-to-value ratio greater than 100% nearly doubles the risk of foreclosure); Elizabeth Laderman & Carolina Reid, Fed. Reserve Bank of San Francisco, Working Paper No. 2008-5, Lending in Low- and Moderate-Income Neighborhoods in California: The Performance of CRA Lending During the Subprime Meltdown 15 (Nov. 2008), available at www.frbsf.org (finding “that other loan features—such as the presence of a prepayment penalty at origination, a fixed rate interest loan, a high loan-to-value ratio, a large monthly payment in relation to income, and the loan’s level of documentation—all have a significant effect on the likelihood of foreclosure, even after controlling for whether the loan was a higher-priced loan or not”); Roberto Quercia, Michael A. Stegman & Walter R. Davis, Ctr. for Cmty. Capitalism, Kenan Inst. for Private Enter., Univ. of N.C. at Chapel Hill, The Impact of Predatory Loan Terms on Subprime Foreclosures: The Special Case of Prepayment Penalties and Balloon Payments 28–29 (Jan. 2005) (subprime refinance ARMs are 50% more likely than fixed rate subprime refinance loans to result in foreclosure); Morgan J. Rose, Fed. Reserve Bank of Chicago, Predatory Lending Practices and Subprime Foreclosures—Distinguishing Impacts by Loan Category 45 (Dec. 2006), available at www.chicagofed.org (fixed rate refinance subprime loans with both prepayment penalties and balloon payments increase the rate of foreclosure by 227%); Ellen Schloemer, Wei Li, Keith Ernst & Kathleen Keest, Ctr. for Responsible Lending, Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners 21 (Dec. 2006), available at www.responsiblelending.org (higher risk for foreclosure for adjustable rate loans, loans with balloon payments, loans with prepayment penalties, and limited documentation; loans originated with less than full documentation in 2003 had a 63.7% higher risk of foreclosure). Cf. Susan E. Barnes, Patrice Jordan, Victoria Wagner & David Wyss, Standard & Poor’s, Standard & Poor’s Weighs in on the U.S. Subprime Mortgage Market 12 (Apr. 5, 2007) (subprime loans with no documentation and piggyback loans show pattern of default within four months of origination); Keith Ernst, Ctr. for Responsible Lending, Case Study in Subprime Hybrid ARM Refinance Outcomes (Feb. 21, 2007), available at www.responsiblelending.org (less than three years out, 8.5% of 106 hybrid subprime ARMS made by Option One in 2004 had been foreclosed on); Andrey Pavlov & Susan Wachter, The Wharton Sch., Univ. of Pa., Aggressive Lending and Real Estate Markets 13 (Dec. 20, 2006) (each 1% increase in purchase money adjustable rate mortgages leads to housing value decline—itself a risk for foreclosure—of 1.3%).

  • 290 {212} E.g., 74 Fed. Reg. 44,522, 44,540 (July 30, 2008) (“Payment increases on 2-29 and 3-27 ARMs have not been a major cause of the increase in delinquencies and foreclosures because most delinquencies occurred before the payments were adjusted.”); Lynne Dearborn, Mortgage Foreclosures and Predatory Practices in St. Clair County, Illinois, 1996–2000, at 23 (July 2003) (from 1996 to 2000, the proportion of foreclosure judgments attributable to adjustable rate mortgages rose from 11% to 30%; at the same time, the median age of the loan entering foreclosure declined from 4.1 years to 2.06 years); Anthony Pennington-Cross & Giang Ho, Fed. Reserve Bank of St. Louis, Working Paper No. 2006-042A, The Termination of Subprime Hybrid and Fixed Rate Mortgages 15–17 (2006) (hybrid 2/28 ARMs have a higher probability of default at any age and the rate of default increases during the first two years, even before any payment shock); Morgan J. Rose, Fed. Reserve Bank of Chicago, Predatory Lending Practices and Subprime Foreclosures—Distinguishing Impacts by Loan Category 25, 32 (Dec. 2006), available at www.chicagofed.org (discussing balloon payments; showing mean age at foreclosure of loans in study was shorter for ARMs than for fixed rate mortgages, with the average purchase money ARM that entered foreclosure taking only 12.4 months to enter foreclosure from origination and the average refinance 13.3 months). See Susan E. Barnes, Patrice Jordan, Victoria Wagner & David Wyss, Standard & Poor’s, Standard & Poor’s Weighs in on the U.S. Subprime Mortgage Market 12 (Apr. 5, 2007) (increase in early payment defaults within four months of origination, particularly for loans with low documentation and a piggyback loan); Office of Pol’y Dev. & Research, U.S. Dep’t of Hous. & Urban Dev., Report to Congress on the Root Causes of the Foreclosure Crisis 28–29 (2010), available at www.huduser.org (collecting studies). Cf. Ellen Schloemer, Wei Li, Keith Ernst & Kathleen Keest, Ctr. for Responsible Lending, Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners 26–27 (Dec. 2006), available at www.responsiblelending.org (discussing various problems in underwriting practices that may lead to high default).

  • 291 {213} See, e.g., Wall Street and the Financial Crisis: The Role of High Risk Home Loans: Hearing Before the Subcomm. on Investigations of the S. Comm. on Homeland Security & Governmental Affairs, 111th Cong. 4 (2010) (Subcomm. exh. 1b) (detailing “Washington Mutual Practices That Created a Mortgage Time Bomb”). Cf. 74 Fed. Reg. 44,522, 44,540 (July 30, 2008) (stated-income loans were “a major contributor to these delinquencies”).

  • 292 {214} See Susan E. Barnes, Patrice Jordan, Victoria Wagner & David Wyss, Standard & Poor’s, Standard & Poor’s Weighs in on the U.S. Subprime Mortgage Market 12 (Apr. 5, 2007) (increase in early payment defaults within four months of origination for loans with low documentation and a piggyback loan).

  • 293 {215} Robert B. Avery, Kenneth P. Brevoort, & Glenn B. Canner, Higher-Priced Home Lending and the 2006 HMDA Data, Fed. Reserve Bull. A123, A138 (2006), available at www.federalreserve.gov.