Study Predicts Rise in Bad Credit Mortgage Troubles
Nearly a fifth of consumers with bad credit who borrowed money to buy a house in the past two years will default on the mortgages and lose their homes, an industry survey obtained by Business Week projects.
A study released Tuesday by the Center for Responsible Lending found that “subprime” or bad credit mortgage loans to consumers with blemished or limited credit histories, have become riskier due to a cooling housing market and relaxed lending standards.
The Center for Responsible Lending is a non-profit research organization that fights predatory lending practices. It predicts lenders will foreclose on 19 percent of the subprime mortgage loans issued in 2005 and the first three quarters of 2006.
Subprime mortgage lenders have little incentive to guard against the bad credit of prospective borrowers. This is because lenders pool bad credit home loans to sell them as mortgage-backed bonds, placing the risk of default with investors in the secondary market.
Therefore, lenders’ only real incentive is to issue as many as possible.
Lenders accomplished this during the housing run-up by offering as many bad credit home loan options as could be, with differing structures attractive to borrowers with poor credit, such as loans in which high payments don’t kick in until a few years after the loan.
As housing prices skyrocketed from 2001-2005, many U.S. consumers borrowed beyond their means to buy a home. Lenders issued more than $900 billion in loans to people with bad credit during 2005 and the first three quarters of 2006, comprising a fourth of the mortgage market, according to the CRL.
When housing prices rise, borrowers having trouble with their mortgage payments can borrow against the value of their home to pay off the loan. But as prices fall, distressed borrowers will no longer be able to refinance or sell their homes to avoid foreclosure.
Last week, the Mortgage Bankers Association reported the default rate for mortgage loans shot up dramatically in the third quarter.