US subprime mortgage crisis hurts
individuals and whole communities
By Tony Favro, US Editor

14 April 2007: Homeownership has long been the basis of community revitalization efforts in American cities. Homeowners bring well-documented stability and investment to neighborhoods. The recent rise in mortgage foreclosures, fueled by subprime lending, seriously threatens neighborhood stability and revitalization.

| Growth of lending | Disparities & foreclosures | City responses |

Home purchases in the United States are typically financed by mortgage loans. Home mortgages are indexed to the prime rate, that is, the interest rate commercial banks charge their most creditworthy customers.

Mortgages with the lowest interest rates are available to customers whose creditworthiness, or ability to repay the loan, is so high that there is little risk to the lender. “Subprime” mortgages are offered to borrowers who don’t meet the credit standards for borrowing in the prime market. These loans are more expensive for borrowers with rates higher than prevailing prime rates, presumably to compensate lenders for the additional risks associated with lending to less creditworthy borrowers. Subprime loans are characterized by low ‘introductory’ interest rates, usually for the first two or three years. These rates frequently rise rapidly in subsequent years, resulting in payments that can increase hundreds of dollars each month.

The subprime mortgage market has expanded dramatically in the US, growing at an annual rate of 25 per cent between 1994 and 2005, a tenfold increase in a decade.

In 2005, the number of homeowners defaulting on their subprime mortgages began to soar. The Consumer Federation of America, a nonprofit pro-consumer advocacy and research organization, estimates that as many as 2.2 million of the 69 million homeowners in the US are at risk of defaulting on their subprime loans and losing their homes.

The subprime mortgage problem in the United States has rattled world financial markets. The US economy is robust enough to absorb the impact of substantial mortgage foreclosures. The fear among global investors is that the subprime loan crisis is a symptom of deeper, as yet unknown, problems in the US economy.

Subprime mortgage foreclosures are not just a problem for world financial markets. They are a serious problem for American cities. Mortgage foreclosures in the US are geographically concentrated, and much of that concentration occurs in cities.

In Detroit, 24.6 per cent of all subprime loan payments are in arrears for 60 days or more; in Jackson, Mississippi, 22.0 per cent; in Boston, 15 per cent; in Sacramento, California, 14 per cent. Cuyahoga County, Ohio – which includes Cleveland and 58 suburban cities – had 13,000 foreclosures in 2006, up from 2,500 in 1995, according to The New York Times.

A home is generally an individual’s or a family’s largest investment and greatest asset. Therefore, the loss of a home can be a shattering personal tragedy. It is also a neighborhood tragedy. Concentrations of foreclosures can lead to vacant, shuttered properties, which in turn can lead to criminal activity, neighborhood blight, and declining real estate values.

An estimated 10,000 of Cleveland’s 84,000 single-family homes are vacant. In the city’s Slavic Village neighborhood, over 900 homes were abandoned in the past four years. “Our neighborhoods are becoming ghost towns,” said Inez Killingsworth, a neighborhood activist. “You can’t get out. You can’t sell your house. The value keeps decreasing.”

A 2007 study by the Woodstock Institute, a nonprofit community development research group, shows that even a single foreclosure has a negative impact on a neighborhood. Houses within an eighth mile of that foreclosure immediately lose one per cent or more of their value.

The report also notes “a clustering of foreclosures around low-income and minority communities,” where residents often have little job security, little financial savvy, low creditworthiness, and few borrowing options.

Growth of subprime lending
In 1994, fewer than five percent of mortgages in the US were subprime, but by 2005 nearly 20 percent of new mortgage loans were subprime. The sharp increase is due primarily to changes in the banking system.

Fifteen years ago, American communities were served by commercial banks, which offered almost exclusively fixed-rate, prime-market mortgages. Few alternative mortgage products were available to consumers.

Today, commercial banks are no longer the leading originators or holders of residential mortgages. Changes in federal laws now allow other financial institutions such as insurance companies, stock brokers – even Wal-Mart – to offer mortgages. Mortgage brokers and mortgage finance companies compete aggressively with traditional banks to offer new products to consumers. The increased competition has resulted in a wide variety of mortgage products and choices for prospective homeowners, including subprime loans.

In 2005, interest rates began to rise in the US after a decade of stable or gradually declining rates. As a consequence of rising interest rates, demand for homes fell. Home sales began to slow, leading to falling home prices.

Many homeowners with subprime mortgages were hit with a double blow. They couldn’t cope with payment increases, nor could they sell their homes or refinance their high-cost mortgages because of the slow real estate market and price depreciation. In Merced, California, for example, the Wall Street Journal recently reported that homes were 77 per cent overvalued, the city had the nation’s sixth highest share of subprime loans (21.6 per cent), and the rate of mortgage foreclosures increased 50 per cent since 2005.

Disparities in lending and foreclosures
Subprime mortgages have helped expand homeownership for all racial and income levels in the US. Between 1995 and 2006, the homeownership rate increased seven per cent among white households, 13 per cent among African-American households, and 18 per cent among Latino households. In lower-income urban neighborhoods, the rate of homeownership grew six per cent, versus the four per cent growth rate in higher-income suburban areas.

Despite recent gains in homeownership rates, minorities are facing foreclosure or losing their houses disproportionately. A 2007 study by the Center for Responsible Lending, a nonprofit homeownership research group, concludes that African-Americans and Latinos are more likely than whites to be steered into high-risk subprime mortgages.

This national study, based on information from the US Federal Reserve and replicated by several smaller studies, demonstrates that Blacks are 3.2 times more likely to receive a subprime loan than white borrowers. After adjusting for differences in credit scores, income, and other risk factors between average Black and white borrowers, the study finds that Blacks are still 1.6 times more likely to get a subprime loan than whites when purchasing a home.

These findings are not surprising. Minorities in the US have a long history of rejection from prime-rate lenders. And American city governments – responsible for most of the nation’s poor minorities -- have had to acquire expertise in loss-mitigation techniques, alternative mortgage financing, and legal issues related to subprime lending and personal bankruptcy in order to combat mortgage foreclosures.

City responses
While the federal government debates how to better regulate subprime lenders and protect subprime borrowers, cities are left to deal with foreclosed homes and devastated families.

Urban poor and minority homeowners are particularly vulnerable to foreclosure when they or a family member experience one or more of the “six D’s: disability, disease, death, divorce, discrimination, and downsizing (job loss),” according to Bob Barrows, a housing consultant and retired Director of Housing and Project Development for the City of Rochester, New York.

Rochester has the oldest active mortgage default counseling program in the US. Operating since 1988 in partnership with the nonprofit Housing Council of Rochester, the widely-publicized program is available to all city homeowners who meet certain income guidelines. The program offers pre- and post-purchase counseling in debt-management, family-budgeting, home maintenance, foreclosure-prevention, and refinancing.

In 2000, Rochester funded a major study of foreclosures in the city. The study led to several innovative initiatives, including city-funded mortgage relief grants to bring eligible homeowners current on their mortgages and a partnership with the nonprofit Empire Justice Center to bring lawsuits against predatory lenders.

The Rochester experience is emblematic of how many US cities now confront foreclosures. Cities are gaining the requisite financial and legal knowledge. They are partnering with nonprofit organizations to provide early-delinquency intervention, counseling, and financial assistance; and they are beginning to pursue subprime lenders in the courts. For example:

The Mortgage Foreclosure and Prevention Program in Minneapolis and St. Paul, Minnesota works with a network of community-based organizations to provide in-depth counseling on financial and personal issues, intervention and advocacy with mortgage lenders, and assistance in accessing funds for homeowners at risk of losing their homes.

Chicago’s well-advertised Home Ownership Preservation Program works directly with subprime lenders to mitigate foreclosures by working out payment terms for homeowners who fall behind on their loan payments. The program also provides financial assistance through a multi-million dollar loan program, and offers homeowner counseling. HOPP is credited with preventing nearly 1500 foreclosures in targeted Chicago neighborhoods where the foreclosure rate is up to five times the national average.

The Colorado Housing Counseling Coalition is a diverse network of nonprofit organizations which offers a wide range of services (i.e., debt counseling, financing, home maintenance, etc.) to a broad range of clients (i.e., elderly, families, disabled, etc.). The Coalition applies whatever resources its member organizations can offer to homeowners at risk of foreclosure, by referring homeowners to other members as necessary. The Coalition works in Denver and other Colorado cities.

NeighborWorks of West Vermont works with homeowners in the small town of Rutland, Vermont (population 17,000) and three rural counties. It provides loans for housing repairs and family emergencies and offers extensive homebuyer education classes and family counseling. The goal of the program is to build relationships with homeowners that last beyond the initial purchase and become a long-term resource for them.

Most foreclosure intervention programs in the US focus on low-income minority neighborhoods that have seen a dramatic rise in subprime lending over the past two or three years. With great effort, these programs can help prevent foreclosures. But they can’t stop subprime lending.

Twenty per cent of subprime mortgages originated since 2005 are expected to end in foreclosure, according to the Center for Responsible Lending. The damage to American cities will therefore continue, undermining years of neighborhood revitalization efforts.

Unless otherwise noted, all data in this article are from the US Federal Reserve Bank.