If it looks like a bubble, smells like a bubble and tastes like a bubble, it must be a bubble.
Or is it?
The smart money now says the U.S. housing market, overall, is not in a bubble. But at least one part of the market certainly looks pretty frothy — the mushrooming “subprime” mortgage market for borrowers who can’t get standard loans. Now that bubble seems to be bursting.
On Wednesday, the large mortgage firm HSBC Holdings, a big player in the subprime market, said its bad debts exceeded $10.5 billion for 2006. On Thursday, shares of a number of mortgage lenders plunged as worry about mortgage defaults spread.
Last week, the Senate Banking Committee held a hearing on predatory lending practices, most involving subprime loans.
And on Friday, the Mortgage Bankers Association felt compelled to defend its members with a 13-point “fact sheet” arguing that subprime loans are “not a problem.”
Subprime lending rose from $150 billion in 2000 to $650 billion at the end of 2005, and now accounts for more than 20 percent of the mortgage market, the government says.
In theory, subprime loans can be good. In exchange for higher-than-usual interest rates, loans are offered to people who otherwise could not buy homes because of low incomes or tarnished credit.
But studies have shown that mortgage brokers and other lenders often press subprime loans on borrowers who actually could qualify for conventional mortgages with lower interest rates. Why? Because the lenders pay the brokers bigger commissions on subprime loans.
To make matters worse, about 80 percent of subprime loans carry interest rates that adjust every 12 months, starting after the loan has been held for two years. Many people who got these loans in 2005 are now seeing their monthly payments jump by 30 percent to 50 percent.
Finally, about 70 percent of subprime loans, unlike conventional ones, carry prepayment penalties that can trap borrowers by charging thousands of dollars if they refinance within the first three to five years.
The non-profit Center for Responsible Lending estimates that 20 percent of the subprime loans issued over the past two years will wind up in foreclosure, perhaps driving more than 2 million families from their homes.
What’s the solution?
Some consumer groups have proposed a “suitability standard” to require brokers to put the borrower’s interests first when recommending a loan. Stockbrokers work under such a rule and can be banned from the business for violations.
Another remedy would be to require better disclosure of mortgage brokers’ commissions, so borrowers can tell if they’re being pushed toward a loan that’s more profitable for the broker than others.
Of course, borrowers need to do their part. If you are offered a subprime loan, ask lots of questions. Is there a prepayment penalty? What’s the highest rate the loan could go to down the road? Are there other loans you can qualify for?
Shop for loans which have lots of advice on subprime loans.
In the end, you may decide it’s better to continue renting rather than to take out a mortgage that could bankrupt you.
What if you have a subprime loan and the payments are soaring? The fact that you’ve had a loan for a year or two may have improved your credit rating. Get a free credit report by calling 877-322-8228. Then shop for a 30-year, fixed-rate loan to replace the subprime mortgage.
Your chances of wriggling free of any prepayment penalty are not terribly good. But you might improve them by getting a credit counseling agency to call the lender. The U.S. Department of Housing and Urban Development has a referral service at 800-569-4287.