A study released by the Federal Reserve Bank of Boston on May 30 offers seven facts regarding the subprime-lending crisis, several of which contradict claims frequently made in the media. The report’s facts are primarily based on the results of an analysis of property level foreclosure data in Massachusetts. The authors acknowledge in the report’s abstract that the facts might not be universally true: “Many of these facts are applicable to the crisis at a national level, while some illustrate problems relevant only to Massachusetts and New England.”
The authors’ first claim lends itself to the most questions; the authors find that despite reports in the press, adjustable-rate subprime mortgages with low “teaser” rates and very high reset rates cannot be a significant cause of the crisis because, by and large, they do not exist. The paper reports that the initial rates of subprime mortgages were relatively high, about 3% higher than rates for equivalent prime mortgages. Additionally, when these loans reset the rates did not increase astronomically, the authors found. The study found the rates increased by three to four percentage points, a monthly payment increase of about 25%. While this increase is significant, the authors argue it is low compared to analogous rate increases in other areas such as the credit cards market. The authors found that the percentage of defaulted mortgages jumps to more than 1.5% just one year after the mortgage originates, yet lenders do not typically reset the interest rates until after two years. This default percentage increase means that households are not foreclosing simply because of reset rates, according to the authors.
The study’s second fact is that the major cause of the increase in foreclosures is the drop in house prices. According to their data, a house that decreases by 20% or more in value is 15 times more likely to undergo foreclosure than a house that appreciates by 20% or more. The authors report that depreciated home value coupled with a personal financial shock like unemployment or illness leads to most foreclosures. With negative equity, these borrowers cannot profitably sell or refinance their homes and have few options other than foreclosure.
For its third fact, the authors find that most of the subprime borrowers could not have qualified for prime loans. According to the data, 70% of subprime borrowers had FICO credit scores