St. Louis Fed: Subprime Mortgages Didn't Lead to More Homeowners

A report from the Federal Reserve Bank of St. Louis suggests that the number of subprime mortgage loans terminated between 2001 and 2006 outweighed the number of estimated first-time homebuyers who sought subprime mortgages. The analysis appears in the March/April issue of Review, the St. Louis Fed's bi-monthly journal of economic and business issues, and was conducted by Yuliya S. Demyanyk, a senior research economist with the Federal Reserve Bank of Cleveland and formerly of the St. Louis Fed. She focused on whether borrowers intended to keep their subprime mortgages long enough to substantiate an increase in homeownership or planned a quick exit strategy at origination, using subprime loans as bridge financing to speculate on house prices — in other words, quickly sell the house for profit after its value increased. Ms. Demyanyk found almost half the loans originated between 2001 and 2006 exited the market either through prepayment or default within the first two years of origination and about 80% did so within three years of origination. "Subprime mortgages were very risky all along," she said. "The extent of their risk, however, was hidden by the rapid appreciation in house prices, allowing termination of the mortgage by refinancing or prepayment. When prepayment became costly — with zero or negative equity in the house increasing the closing costs of refinancing — defaults took their place." The number of defaults in the limited sample of subprime purchase-money mortgages within two years of origination is almost equal to the number of first-time homebuyers who took a subprime mortgage. "If the data for the rest of the market were available," said Ms. Demyanyk, "the number of defaults would no doubt be even greater."