A Regional Look at Subprime Mortgage Foreclosures

Subprime lenders target prospective homebuyers who do not have the credit history, credit score, or income to get a prime loan. Under traditional lending standards, subprime borrowers would not be able to secure a mortgage. Subprime loans are a riskier loan due to an increased probability of default. In order to be compensated for that risk, subprime lenders charge a higher interest rate on subprime loans than prime loans.

Some subprime borrowers took advantage of subprime adjustable rate mortgages (ARM), which allow people to afford a home that they normally could not by keeping interest rates (and mortgage payments) initially low. The “2/28” subprime ARM is popular among subprime borrowers. It keeps mortgage payments low for the first two years before the interest rate on the mortgage adjusts to the market’s variable interest rate for the next 28 years. The caveat of the subprime ARM is that the interest rates that borrowers pay are substantially higher than a prime ARM or a conventional prime loan, due to the borrower’s high-risk factor.

The preceding table uses data from the Mortgage Bankers Association to rank the states that experienced the largest increase in subprime foreclosures, in percentage terms, in the fourth quarter of 2006. The columns with a single asterisk (*) include all foreclosures in inventory at the end of the fourth quarter of 2006. The column with a double asterisk (**) includes foreclosures that started in the fourth quarter of 2006 (data for the total inventory was not available).

Ohio saw the largest rise in subprime foreclosures in the fourth quarter, at over twice the nation’s 4.5% increase. Many of the states with high subprime foreclosures are in the Midwest, where automotive plant closings have helped to elevate the unemployment rate. Not surprisingly, 6of the 10 states with the highest percent increase in subprime foreclosures, also have unemployment rates that were above the United States average in 2006. In addition, though it is not shown in the table, 8 of the 10 states with the highest subprime foreclosures (Louisiana and Mississippi being the exception due to bounce-back income growth after the Gulf hurricanes of 2005) also had below-average personal income growth in 2006. The combination of high unemployment rates and weak personal income growth, along with adjustable interest rates that have climbed substantially, has translated into a subprime mortgage crisis that could affect the nation’s housing landscape for some time.

The data indicates that some of the fears about subprime mortgages are being realized. In particular, that subprime borrowers will not be able to maintain their mortgage payments and that there will be a rapid increase in subprime foreclosures. This is especially true with subprime ARM borrowers, because the ARM mortgages have resulted in very large increases in mortgage payments. This increase in foreclosures could have a negative effect on the overall economy, contributing to a slowdown in growth.

by Ron Thompson