Subprime Borrowers Six Times as Likely to End in Foreclosure

Homeownerships that are financed with a subprime mortgage are six times as likely to end in foreclosure than those that begin with a prime purchase mortgage. That’s the finding of a new working paper from the Federal Reserve Bank of Boston.

The authors analyzed homeownership in Massachusetts during the period 1989-2007. Their findings are that the probability of default for a home that is financed using a subprime mortgage is 18% as compared to 3% for prime borrowers.

According to the study, this may validate claims that some people might be better suited to not owning property.  However, the answers are not so obvious.  In an effort to assess root cause, the authors segment the data to only include borrowers who initially financed the purchase of a home through a subprime mortgage and not those who transitioned to a subprime loan after initially financing a home through a prime lender.  Their research indicates that while 44% of the foreclosures studied were of borrowers whose last mortgage was originated by a subprime lender, about 60% of those were homes originally financed through a prime lender, then refinanced into a subprime mortgage.  As such, identifying buyers who are not well-suited to home ownership may be trickier than is often suggested.

The second major finding of the study is that the dominant factor in generating foreclosures is housing price appreciation. According to the authors, the probability of default for subprime and prime borrowers increases significantly in period with low or negative price appreciation:

We attribute most of the dramatic rise in Massachusetts foreclosures during 2006 and 2007 to the decline in house prices that began in the summer of 2005.

The full working paper, Subprime Outcomes: Risky Mortgages, Homeownership Experiences, and Foreclosures is available for free download.

Technorati Tags: Federal-Reserve-Bank-of-Boston, foreclosures, subprime-mortgage

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Tuesday, December 4th, 2007 : Credit Research, Economic Research, Public Sector : 1 Comment

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