Risky mortgage products, not risky borrowers, are the root cause of the mortgage default crisis, according to findings from a new study of default rates among low-income and minority home buyers conducted by the University of North Carolina at Chapel Hill's Center for Community Capital.
The results of the study show that home loan borrowers with similar risk characteristics defaulted at much higher rates when they borrowed subprime mortgages than when they received loans made primarily for Community Reinvestment Act (CRA) purposes.
"The results are timely given the frantic rush to identify culprits in the financial crisis and to develop policies to rescue and rebuild the mortgage market," says center director Roberto Quercia. "These results show clearly that mortgages made using traditional affordable housing guidelines are holding up much better than subprime mortgages. Homeownership can remain an important and primary path to financial security for Americans, even among those of modest means, as long as home buyers have access to safe-and-sound mortgage products."
The study, "Risky Mortgages or Risky Borrowers: Disaggregating Effects Using Propensity Score Models," compared the default rates of home mortgage borrowers with similar credit characteristics who received different loan products. One group received loans through an affordable home mortgage program, called the Community Advantage Program (CAP), designed to expand homeownership among lower-income and minority home buyers. The other group received subprime mortgage loans. Researchers compared the default rate (90-day delinquency) within two years of origination. Borrowers with comparable characteristics who had subprime loans were three to five times as likely to go into default as those with CAP loans, the study found.
"By isolating different features of the loan products, we identified major causes of higher default rates," says lead author Lei Ding, a senior research associate at the center. The features most strongly associated with higher subprime defaults were adjustable interest rate, prepayment penalty and broker origination. "The more you layer these features, the higher the likelihood of default," says Ding. By contrast, he says, CAP loans typically are fixed-rate, 30-year-amortizing loans without prepayment penalties, and are originated by banks using significant underwriting regarding the borrower's ability to repay.
Policymakers and industry-watchers alike can learn a great deal from this study, Quercia says. "It is crucial to draw a distinction between affordable housing loans and the subprime loans that later flooded the market," he says. "Though these affordable home loans may have acted as a substitute for non-prime loans on the front end, they have performed starkly better in terms of safety and soundness for borrowers and lenders alike."
The full report is available online http://www.ccc.unc.edu/documents/RiskyBorrowers_RiskyMortgages_1008.pdf
Home mortgage finance is a key area of research and analysis for the UNC Center for Community Capital, the leading center for research and policy analysis on the transformative power of capital on households and communities in the United States. The center, based in UNC's College of Arts and Sciences, offers in-depth analyses that help policymakers, advocates and the private sector find sustainable ways to expand economic opportunity to more people, more effectively.