Does the Subprime Market Reduce Home Ownership?

Does the Subprime Market Reduce Home Ownership?

Most recent commentary on the subprime market looks to removing abuses from that market -- not shutting it down. Underlying this note of caution is an assumption that, while a lot of bad things have happened in the subprime market, on balance it serves a socially useful purpose. While foreclosures are too high, the market has made home ownership possible for many who could not have achieved it otherwise. But this assumption has now been challenged. The Center for Responsible Lending (CRL), an influential consumer group, claims that the subprime market causes a net loss in home ownership. (See Subprime Lending: A Net Drain on Home ownership, available on its Web site.) This implies that, if the subprime market were shut down, home ownership would rise, a startling claim that deserves careful scrutiny.
To determine whether the subprime market increases or decreases home ownership requires a comparison of two numbers. The first is the number of home owners who would not be home owners if not for the subprime market. The second is the number of non-home owners who would be home owners if not for the subprime market. If the second number is larger than the first, which the CRL claims to be the case, the market reduces home ownership.

Running the Numbers on Home Ownership

The CRL measures the positive contribution of the market as the number of subprime loans to first-time home buyers. It measures the negative contribution of the market as the number of subprime foreclosures.
I will use the year 2006 as an illustration because it is the year when, according to CRL, the net loss from foreclosures peaked. Their figures show that in 2006, some 3.2 million subprime loans were made, of which 1.4 million were to purchase homes. However, only about 354,000 of those were to first-time buyers, while about 625,000 subprime loans were foreclosed. CRL subtracts 354,000 from 625,000 to get a net home ownership loss of 270,000.
Parenthetically, CRL ignores the million-plus subprime home purchasers in 2006 who where not first-time buyers. Their focus is on the home ownership rate, and these buyers already owned their homes. However, a balanced evaluation of the subprime market should not ignore its role in enabling existing home owners to upgrade.

Market's Contribution Positive, Not Negative
But returning to the main question: Was the subprime market responsible for a net loss of 270,000 home owners in 2006? It was not -- the market's contribution to home ownership was positive, not negative.
CRL's mistake is assuming that every foreclosure of a subprime loan reduces the number of home owners by one, relative to what it would have been had the subprime market not existed. That is far from the case.
On subprime purchase loans that foreclose, CRL implicitly assumes that the borrower could have purchased with a prime loan which would not have foreclosed. Of course that happens, but not very often. Based on my experience, perhaps one purchaser of 10 using a subprime loan could have qualified with a prime loan.
Most Subprime Purchasers Need Subprime Loans
The other 90% of subprime purchasers needed a subprime loan to qualify. Their foreclosure did not reduce the number of home owners because, had they been unable to obtain subprime loans, they would not have become home owners in the first place.
On subprime refinance loans that foreclose, CRL implicitly assumes that the loans would not have gone to foreclosure had the borrower not refinanced into the subprime. This is also true in some cases, but is far from the rule. Most foreclosures are triggered by job losses, illness, marital problems and similar factors that overwhelm the borrower regardless of the type of mortgage the borrower has.
Because deceptive solicitations are more common in refinance than in purchase transactions, perhaps as many as 20% of refinance foreclosures would not have occurred had the borrower not refinanced into a subprime loan. The other 80% would have gone to foreclosure had the borrower refinanced with a prime loan or not refinanced at all.
Applying my estimates, and assuming the distribution of foreclosures among purchases and refinances is the same as on new loans, the 632,000 subprime foreclosures in 2006 accounted for a reduction of about 101,000 in the number of homeowners. That is less than a third of the 354,000 subprime loans made to first-time buyers in that year.
Of course, my numbers are only educated guesses. They may be too high or they may be too low. I would like to see an unbiased effort to dig deeper than I have been able to do. Meanwhile, the widely held proposition that the subprime market makes a positive net contribution to home ownership still stands.

Comments :

I am not convinced that Nemo is right about "easy credit" artificially inflating home prices. While it is true to home prices have soared in the last few years (especially in California), there is more involved than just demand at play. First of all, housing supply is not as limited as he suggests; with new homes comming on the market in direct connection with the demand. Second, prices will increase durring a seller's market, but that is true no matter the credit worthyness of the buyers. Third, a QUALIFIED borrower is anyone who purchases a home they can afford, it is when people demand more house for less money that they get in trouble with ARM and NegAm loans. Geographically, those places suffering from the highest percent of foreclosures are also those places with struggling economies, as people loose their jobs they are likely to loose their home shortly thereafter. Finally, and I think this is important, rising home value is a GOOD thing. Many of the current problems have come about because borrowers and banks bet that their risky loans would be covered by increases in home prices. They assumed that they would be able to tap into the equity they accrued even though they only made interest payments on their loans. As a first time homebuyer I only wish that the higher price I paid for my home in California will have the kind of 10 year return Mikeaao mentions.

Comment 2 :

Your accounting is a little oversimplified. You didn't address the effect of "easy credit" including subprime loans on the PRICE of housing. If everyone can suddenly qualify for a loan, everyone borrows. With a limited stock of housing, prices soar. Without that demand, inflamed by irresponsible borrowing and lending, wouldn't buyers have found housing less expensive, and therefore more available to QUALIFIED borrowers?

Comment 3 :

Absolutely, I agree with Nemo. Homes that we selling here in California's central valley for $80K in 1995 and $125K in 2000 were fetching over $300K in 2005!!! Insanity. This easy credit also made it possible for people to buy large expensive homes they had no business buying.