Housing Policy: The Shaky Foundation

Subprime Mortgage Market Growth

The deep recession the United States entered in 2007, sometimes described as the Great Recession,¹ started with the deflation of a housing bubble. To understand what went wrong in the housing market, one has to understand the role of subprime mortgage lending—loans designed for borrowers with blemishes on their credit records. In 2005 and 2006, subprime mortgage loans made up 23 percent of all home loans written. Yet as recently as the mid-1990s, they were an insignificant share of the mortgage lending market.

Because lenders are taking on added risk by lending to people with weaker credit, interest rates on these loans are higher than the prime rate. Originally, subprime loans were handled by local nonprofit organizations and community banks, which screened borrowers carefully to make sure they were capable of meeting their mortgage payments. If borrowers started to fall behind, lenders worked with them to minimize the risk of their defaulting on the loan. In most cases, default rates were lower than for prime-rate borrowers.²

In the 1990s, Congress deregulated real estate lending markets to enable other kinds of institutions to expand into subprime lending. By the early 2000s, subprime lending looked nothing like before. The neighborhood nonprofits that had been doing such a responsible job were crowded out of the market, replaced by anyone who wanted to call himself a mortgage broker. What followed could have been predicted. No longer was it necessary for borrowers to come up with the customary 20 percent down payment on a house. In the new subprime market, borrowers could get a loan with no money down. There were “NINJA” loans (No Income, No Job or Assets) and “liars’ loans” that resulted from borrowers’ being cajoled into claiming any income that looked good on the application.

Communities of color were targeted aggressively by predatory mortgage lenders who operated with virtual impunity.

In 2000, Carol Mackey of Rochester Hills, MI, a suburb of Detroit, contacted the American Equity Mortgage Company for a home equity line of credit to pay off a credit card debt and make some renovations on her condominium. A loan officer at the company persuaded her that it was in her best interest to refinance her mortgage. She did so, and soon thereafter the interest rate on the loan skyrocketed and Mackey could not afford to make her mortgage payment. Included in the fine print, but never mentioned by the loan officer, was a prepayment penalty that meant she couldn’t get out of the loan.

“My son contacted American Equity Mortgage on my behalf, and was directed to the General Counsel of the company. He explained to the General Counsel that he believed that I had been a victim of predatory lending practices by American Equity Mortgage. He discussed the facts of the situation and requested that American Equity Mortgage cancel the new mortgage, replacing it with a revised mortgage that reflected the interest rate of my original mortgage, blended with what a reasonable interest rate on a second mortgage would have been.

“American Equity Mortgage refused, on the basis that the mortgage loan officer stated that I had wanted to refinance my original mortgage from the outset. That is absolutely false. Why would I want to lose a perfectly good 7.5% mortgage? If I had been able to get a Home Equity Loan for $20,000, as I had sought, all of my debts would have been paid and I would still have the $10,000 that I wanted to spruce up my home. And I most assuredly would not be paying more than double what my mortgage payment was before this all started.”

In 2001, Mackey explained what had happened to her at a hearing before the U.S. Senate Committee on Banking, Housing and Urban Affairs.³ The hearing included other victims from around the country, describing similar experiences with their lenders. American Equity Mortgage came out looking neither better nor worse than its peers in the subprime lending business. It weathered the shame of its exposure before Congress and continued to make money from the same kind of loans.

Some people might argue that since this was perfectly legal, there was nothing wrong with what the company was doing.  But deregulation allowed predatory lenders to ride roughshod in low-income communities with impunity. Communities of color were targeted especially aggressively by lenders. The subprime mortgage market that ensnared Carol Markey was tearing up communities of color in the early 2000s. The amount of housing wealth stripped from African American and Hispanic families has been staggering. In 2008, Bread for the World Institute published a study showing the extent to which low-income communities were saturated in subprime loans. Our study found that where poverty rates were highest, so were the percentages of homeowners with subprime mortgages.⁴

In This Section

• The Subprime Bomb Explodes
• Striking a Better Balance on Housing Policy

Issues