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Special Reports
Not Your Father's ARM Loan
Consumer Group Studies Subprime ARM Foreclosure Rates
By Jennifer Harmon
CHAPEL HILL, NC--A study by the Center for Community Capitalism at the University
of North Carolina here shows that victims of predatory loans in the subprime home mortgage market face up to a
50% greater risk of undergoing foreclosure because of prepayment penalties and balloon payments.
According to the study, which looks at the odds of foreclosure for borrowers who
take out adjustable-rate mortgages in the subprime market, subprime loan originations grew more than ninefold,
from $35 billion to $332 billion between 1994 and 2003. In the fourth quarter of 2003, 2.13% of all subprime loans
across the country entered foreclosure, which was more than 10 times higher than the rate for all prime loans.
During a teleconference, Michael Stegman, the author of the study and director
of the center, said 20.7% of all first-lien subprime refinance loans originated in 1999 had entered foreclosure
by December 2003. Mr. Stegman said he hopes the study, which tracks loans from January 1999 to December 2003, will
encourage lawmakers at the state and federal level to consider legislation that would ban these fees and balloon
payments.
In absence of a national law, the Home Ownership and Equity Protection Act allows
prepayment penalties for up to five years into the loan term, he said.
"The federal law does not adequately address this issue," said Mr. Stegman.
"There is strong debate over whether Congress will create one national predatory loan law. If there is one,
we hope it is significantly along the lines we are suggesting."
The study shows a prepayment penalty is costly when applied unfairly and offers
no interest rate benefit, said Keith Ernst, senior policy counsel, Center for Responsible Lending, which covered
the costs of the study. "All prepayment penalties and balloon payments in the subprime market are predatory.
The study shows they are harmful to borrowers. The evidence shows it is not anecdotal," he said.
Among its findings, the study found home loans with prepayment penalties with
terms of three years or longer faced 20% greater odds of entering foreclosure than loans without the penalties.
It said subprime home loans with balloon payments where a single lump sum payment is many times the regular payment
amount due at the end of the loan term, creates a 46% greater risk of entering foreclosure than loans without such
a term. And according to the study, subprime loans with interest rates that fluctuate are 49% more likely of entering
foreclosure than borrowers with fixed-rate subprime mortgages.
During the teleconference, some questioned the study and its use of "old"
data. Mr. Ernst said, although loans were made more than four years ago, the trend in the subprime market has continued.
"The lessons learned in the study are applicable today. Prepayment penalties
are applied unfairly. They are dangerous and often go to borrowers in rural and minority areas," said Mr.
Ernst.
While the North Carolina predatory lending law bans balloons and prepayment fees
for loans up to $150,000, it has not reduced access to capital in the market, Mr. Ernst added. "Many states
regulate prepayment penalties. North Carolina, Massachusetts, Illinois and New Jersey have all created standards
that weed out predatory lending while allowing the industry to flourish," Mr. Ernst said.
"The OCC has pre-empted states for national banks and their subsidiaries,
but it's important that the terms of these state laws remain enforceable and intact."
In California, Mr. Ernst said borrowers are commonly charged six months interest
in prepayment penalties. "For example, on a $150,000 mortgage, the borrower could pay 6% in prepayment penalties
if they refinance. This study shows that states that have not acted to pass an anti-predatory lending law are placing
their borrowers at risk."
Colorado was listed as one of the states with a high foreclosure rate in the study.
Among a total of 3,535 loans, 993 did not have prepayment penalties, 55 of which experienced foreclosure. And 2,542
had prepayment penalties and 381 were in foreclosure.
Wil Armstrong, chairman of the Colorado Mortgage Lenders Association, said foreclosures
are less a function of the products and the loans borrowers are in, but based more on the economy and job market
of each state. The subprime market has to do with credit, so it would make sense that foreclosures are higher there,
he said.
"In Colorado, our economy has been hurt. There are times when it has been
more difficult from a job standpoint," Mr. Armstrong said. "Clearly, the borrower can get into loans
they shouldn't be -- prepayments, balloons, ARMs. I don't deny it. I'm an 'A' borrower with a 700-plus credit score,
and I have a prepayment penalty, and clearly it's not predatory."
Mr. Armstrong said he thinks any time the government tries to limit a product
or practice, it only restricts credit and hurts the people they are trying to protect.
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