OCC Releases A Study of Foreclosures of Subprime Mortgages in Chicago

August 30, 2006

Examines the Role of Predatory Lending Practices

Abstract: A dramatic rise in subprime foreclosures over the past several years has led to calls for restrictions of, or prohibitions against, a range of lending practices loosely termed "predatory." Several cities and states have enacted legislation or regulations aimed at eliminating predatory practices, and some advocacy groups have endorsed action nationally. This working paper uses data from the Chicago metropolitan area to examine the impact of two frequently cited predatory lending practices, long prepayment penalty periods and balloon payments, on the probability of foreclosure on subprime refinance and home purchase mortgages. This paper also examines the impact of low- and no-documentation, and how combinations of low- and no-documentation, long prepayment penalty periods, and balloon payments affect foreclosure rates. Findings indicate that the impact of each of those loan features on the probability of foreclosure varies by loan category, meaning whether the loan is a refinance or a home purchase loan, and whether the loan is a fixed-rate mortgage (FRM) or an adjustable-rate mortgage (ARM). Taken individually, long prepayment penalty periods and low- or no-documentation are associated with a greater or lesser probability of foreclosure, or have no significant association, depending on the loan category. Balloon payments are associated with greater probabilities of foreclosure for refinance FRMs, even though at the end of the sample period all of the loans in the dataset have more than two years (and most have more than five years) until their balloon payments are due. This indicates that the inability to make a balloon payment is not the direct cause of these higher foreclosure rates. Interactive effects between these loan features are also found to have sizable impacts on the probabilities of foreclosure. These findings indicate that the relationship between predatory lending practices and foreclosure rates is more complicated than the arguments for restricting their use suggest. Policies that encourage subprime lenders to review and tighten loan underwriting and pricing procedures to ensure that borrowers' abilities to repay their loans are fully reflected in lending decisions and terms may be more effective than prohibitions on specific lending practices. This approach is consistent with the approach taken in the recently proposed Interagency Guidance on Nontraditional Mortgage Products, which emphasizes prudent loan terms and underwriting standards rather than restricting particular loan features.

Contact ALTA at 202-296-3671 or communications@alta.org.

SoftPro, based in Raleigh, NC, offers a mature suite of products, designed specifically for the closing and title industry. Our mission is to serve our client base, with best-in-class products and services. Our products are modular so we don't force you to buy anything you don't need. You can always add on as your business grows. Unlike other software companies, we view the sale as the beginning of the relationship rather than the end. North American Title Insurance Company (NATIC) is a seasoned title insurance underwriter, helping title agents to achieve their individual business goals for more than 50 years. Today, the company conducts real estate settlement services in 39 states and the District of Columbia through a network of experienced, independent agents.