Subprime Loan Problems Coming To A Neighborhood Near You

You can't spend 10 minutes listening to the radio without hearing an ad for a mortgage company which promises all sorts of interest only or low teaser rates "regardless of your credit". I'm sure to some homeowners or wannabe homeowners those loans are a blessing, but for an increasing number of people, those loans are setting up soon-coming problems:

WASHINGTON, Dec. 19 /PRNewswire/ -- A new Center for Responsible Lending (CRL) study reveals that 2.2 million American households will lose their homes and as much as $164 billion due to foreclosures in the subprime mortgage market. Titled, "Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners," the CRL study is the first comprehensive, nationwide review of millions of subprime mortgages originated from 1998 through the third quarter of 2006.

CRL's research suggests that risky lending practices have triggered the worst foreclosure crisis in the modern mortgage market, projecting that one out of five (19.4%) subprime loans issued during 2005-2006 will fail.

"In the subprime sector, the most vulnerable borrowers are sold the most dangerous loans," said Mike Calhoun, CRL president. "At $164 billion, the losses from foreclosures could pay for the college educations of four million kids. For families who lose their houses because their loans fail, savings and economic security will be way out of reach."

The report discusses a number of factors that drive subprime foreclosures -- in the majority of cases, borrowers receive high-risk loan features, packed into an adjustable rate mortgage with a low start rate, that is approved without considering whether the homeowner can afford to pay the loan after the rate rises.

Why would lenders make these risky loans? Because they're money makers even if the homeowner defaults. The equity increases in areas where these loans have been popular (like right here in Southern California) have been so significant that a default has little impact on the lender. They can sell the property and easily recoup any losses.

Should housing prices begin to drop more steeply than they've done recently there will be risk to the lenders and maybe they'll look a little harder at who they're approving for these subprime loans. In areas like Southern California, where even a starter condo can cost $400,000, these "creative" loans are about the only way for some people to buy a house, but if they can't afford the payments after the early teaser rates or interest-only periods go away, there's big trouble coming.