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March 29, 2007

Maybe Subprime Loans Aren't Pure Evil

For the past few months, barely a day has gone by without some newspaper or politician (or blog!) trumpeting the evils of sub-prime mortgages. The case is simple: Predatory lenders foist a complicated new kind of mortgage on a poor, unsuspecting victim which leads to foreclosure two or three years later when the rate ratchets up. An article in today's New York Times, however, provides an interesting counterpoint to the hysteria. The article cites a new study conducted by Kristopher Gerardi and Paul S. Willen of the Federal Reserve Bank of Boston and Harvey Rosen of Princeton called Do Households Benefit from Financial Deregulation and Innovation? The Case of the Mortgage Market which makes the case that the enormous creativity in the mortgage market since 1970 has, on balance, been very favorable. As Professor Rosen explains, just because one is poor doesn't mean you won't make rational use of more creative mortgage products:

Our findings suggest that people make sensible housing decisions in that the size of house they buy today relates to their future income, not just their current income and that the innovations in mortgages over 30 years gave many people the opportunity to own a home that they would not have otherwise had, just because they didn’t have enough assets in the bank at the moment they needed the house.

Rosen also points out that clamping down on the newer mortgage products may end up hurting the very people everyone thinks they're trying to protect.
‘Irresponsible’ Mortgages Have Opened Doors to Many [NY Times]

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"people make sensible housing decisions in that the size of house they buy today relates to their future income"

True, but it's also taking a risk and assuming that you will always make more money, won't lose a job, etc. It's fine to buy a little more house based on future income, but not the way people do it today.

"gave many people the opportunity to own a home that they would not have otherwise had, just because they didn’t have enough assets in the bank at the moment they needed the house."

No one NEEDS a house - they can rent. They should have said at the time they WANTED the house. These products may have helped some, and there are people smart enough to use them to their advantage, but they have fueled feeling of "I want it now" entitlement.

Posted by: Anon at March 29, 2007 9:13 AM

the article makes a good point in noting that the 'vast majority of even subprime borrowers have been making their payments.' there is risk in any huge financial transaction, but just because some people got screwed doesn't necessarily mean it's inherently evil.

in fact, i'm kind of kicking myself for not going subprime, i was just too freaked out by it from everything i'd read. but now i'm starting to think i didn't need to play it so safe.

and yeah, no one NEEDS a house, but by that logic the only people who should buy a house would be cash buyers. did you buy your house all cash?

Posted by: Jimmy Legs at March 29, 2007 9:23 AM

Perhaps it's more of a "I want it" and "now" may be the only time I can get it, because of the deal being touted. Owning will always be a risk **because** you rely on the hope that you will 1) make more money 2) won't lose your job 3) won't get so ill that you can't work, etc. etc.
The bad press seems to be mostly about people who had were clearly high lending risks or people who had perfectly decent, fixed rate mortgages, but were duped into refi and are now losing their homes.

Posted by: jdhs 91 at March 29, 2007 9:29 AM

I've had a couple sub-prime mortgages now and love them. We had a conventional 30 yr mortgage on our first apartment and when we sold it after having it for 3 years, we had paid about 5k worth or principle. Forget it. Our next two purchases we used IO ARMS and we love them; we pay 1k a month less than we would with a traditional mortgage. If you know you're not holding onto a place for a 7 years or so, they make a lot of sense.

Then again, we could pay it off in cash if we needed to. I realize a lot of subprime borrowers are not in our situation. But for some people, they are a great product.

Posted by: Anonymous at March 29, 2007 9:31 AM

I think part of what has fueled so many people who are low-income/have bad credit/have little access to financial resources is this idea that has been ttrumpeted in generla that to rent is a completely bad thing. While I agree and beleive that owning a home is great thing, it's only great if you are financially prepared to do so. Not everyone is ready for this kind of step nor do they understand the consequences, if things should go wrong. Homeownership is a good thing, but it should not be entered into lightly. I'm glad that people have been able to own homes thourhg subprimes mortgages, but there are lots of ways to have a good financial foundation besides owning a home.

Posted by: Anon at March 29, 2007 9:55 AM

Anon 9:31 -- what you describe is not a sub-prime mortgage, it is an unconventional (and probably non-conforming) mortgage that gives you a greater degree of financial flexibility that you are sophisticated enough to manage. Subprime mortgages may have some of the same characteristics (e.g. adjustable interest rate), but are marketed to borrowers with bad credit (usually low income), oftentimes without disclosure of the consequences of future rate adjsutments (higher monthly payments) or default (foreclosure)

Posted by: Anonymous at March 29, 2007 10:09 AM

anon @ 9:31...having I/O ARMs doesn't make you a subprime borrower...subprime borrowers or loans are those made to borrowers who don't qualify from prime (i.e., best rates) financing terms...it can be prime financing for a 30 yr conventional or an I/O ARM...having an I/O ARM is a non-conventional mortgage but NOT subprime.

Posted by: what bubble? at March 29, 2007 10:11 AM

My fiscally conservative Midwestern banker father even says it makes more sense financially for some people to rent in NYC, than to buy.

Posted by: Anonymous at March 29, 2007 10:13 AM

I think the real crime is not in saddling the new purchasers with high risk, it is in putting this risk on refinancers who take too much money and then lose their homes. People who for years paid their mortgage and were ok, now find themselves strapped and in trouble. Too many advertisements enticing people to take the equity out of their homes and splurge on something right now.

Posted by: Gary at March 29, 2007 10:14 AM

christ on a crutch, brownstoner. hey, next time, tell people who are complaining about the price of energy to read a press release from exxon.

Posted by: suzy at March 29, 2007 10:16 AM

I bought my house with a subprime mortgage, because I had bad credit due to some bad business decisions. I was in the process of cleaning up my credit when the opportunity to buy at a great price came up. I had a 12% interest rate at a time when most people had around 6 or 7. The mortgage broker gave me good advice at the time. He said get the house, pay the higher interest for a year or so, don't ever pay a mortgage payment late, fix your credit, and then refi. When I did so, my credit rating was better (not great, but better), I was able to refi, get a lower interest rate and take out enough equity to pay off the rest of my debt. My monthly payments stayed about the same as with the higher rate, but my credit was clean, I had my house, and my place is still worth twice as much as the refied price. Subprime loans can work for you if you take care, and are aware of the risks and how the game is played. The key is to use it to your advantage, and then get out.

This is not the same thing as preditory lending.

Posted by: Anonymous at March 29, 2007 10:22 AM

I think we have gone a bit nuts as a society about the benefits of home ownership. I've both owned and rented and think that most of the time (especially if you don't have a lot of money) renting is a lot cheaper. But people buy into this nonsense of "you're throwing away your money if you rent..."

Posted by: JoshK at March 29, 2007 10:29 AM

Subprime mortgages have higher interest rate potential, because they are issued to individuals with lower credit. While this standard on its face appears to be counter-intuitive, it does allow some individuals with poor credit an opportunity to buy. Is it for everyone, no? Some are not fiscally stable enough to manage such a financial situation. Nonetheless, I think the talk about restricting sub-prime mortgages, because it takes advantage of people who are of lower income and appears to cater towards certain races is rather condescending to the individuals who obtain these mortgages. first off, you assume that these inidviduals do not, and cannot, understand the potential risk. Now, there are many claims that sub-prime lenders did not provide full dis-closure and also purposely hid from the borrowers information regarding the risks of such a loan. This is wrong and illegal, no further legislature is necessary, every state in our nation recognizes a cause of action for fraud, fradulent inducement, and recission. Essentially, I believe the true lesson from this sub-prime mess is to make sound financial investments and esnure you are fully aware of the financial reprecusions of any agreement that you might sign. As mom always said "no one gives you something for nothing," and "always read the fine print." To those who were never allowed the opportunity to read the fine print, do not allow them to walk over you and fight for your rights.

Posted by: Alright Already at March 29, 2007 10:34 AM

Josh and anon 10:13. You're both right. unless you own your home free and clear then you rent. You either rent from a landlord or from the bank if you have a mortgage. Sometimes it is better to rent and put your excess savings in something that will offer a better return.

Posted by: Anonymous at March 29, 2007 10:49 AM

The problem here is some people insist on comparing Apples to Oranges. Thankfully, 'WhatBubble' @10:11 cleared up the confusion in regards to the difference between sub-prime loans & non-conventional loans.

But the arguement about Buying vs. Renting in New York is not black and white. There is the need to compare Apples to Apples.

If it costs you $3,000, all in, to rent the apartment of your choice in NYC, then have to compare that to what size mortgage is comparable, ALL IN, in NYC. A $650K Mortgage +ins. +taxes+maintenance -LESS your tax writeoff benifit will put you around that same $3,000.

So, in today's low interest rate environment, you'll be hard pressed to find an apartment that makes more sense to rent, than a comparable co-op,condo, or brownstone w/ tenants of the same size.

Subprime lending is more a risk to the issuing lender then it is to the borrower. Non-conventional loans, IMHO, are more a risk to the borrowers,becuase I feel those individuals are more likely to underestimate the shock of interest rate adjustments.

Posted by: NewStoner at March 29, 2007 11:07 AM

NewStoner,

I have to disagree with you on the rent vs buy thing. If you count the value of your downpayment and properly factor in maintenance costs, then you are getting a 0 or negative return usually.

Posted by: JoshK at March 29, 2007 11:21 AM

There is a huge difference between predatory lending and an educated consumer taking out an i/o loan.

Posted by: clinton hillbilly at March 29, 2007 11:27 AM

"If it costs you $3,000, all in, to rent the apartment of your choice in NYC, then have to compare that to what size mortgage is comparable, ALL IN, in NYC. A $650K Mortgage +ins. +taxes+maintenance -LESS your tax writeoff benifit will put you around that same $3,000"

Exactly. My one bedroom apt. was going up to $2400 per month, and this did not include heat and hot water. With one baby in hand and plans for a second, a two or three bedroom was not far off at all. Quick math told us that a buy was going to make more sense than a rental.

Do you need a house, perhaps not everyone does, but NewStoner makes the smart point "So, in today's low interest rate environment, you'll be hard pressed to find an apartment that makes more sense to rent, than a comparable co-op,condo, or brownstone w/ tenants of the same size"

Posted by: StonerBrown at March 29, 2007 11:27 AM

Newstoner - sorry but you are way off - with todays inflated sales prices you'd be hard pressed to find a senario where a comparable apartment isnt cheaper to rent.

Your costs of ownership are wrong
Here is a VERY conservative analysis-

$650,000 mortgage = a monthly payment of $4300 ($3600 in int and $700 principal). and then you have taxes - which if you are 421(a) maybe will be $100mo (much higher if you arent exempt) If you are in a 35% bracket this will = $3105 mo payment, then you have to add maintainace which conservatively will=$500mo which puts you at $3605 plus ins (say $75mo), plus small painting/repair allowance ($25mo)= $3705

And then you of course forgot the thing that most forget - the cost of the cash equity = in this case say $275,000 which is $250K+25K in closing costs (low). At the 5% you could earn in a bank account you are talking $13,750 which is $1145 a mo = so grand total of ownership = $4850 a month - Even if you subtract out the equity that you are investing ($700 a month) it still costs you $1150 more to own then it does to rent - assuming prices stay constant.

Obviously if prices rise it will make ownership look better, if prices fall then renting will look even better then above.

Posted by: David at March 29, 2007 11:39 AM

both of the above calculations are wrong: one doesn't include downpayment and closing costs, and the other inflates it tremendously. Most coops allow 20% downpayment, and most condos 10%, so downpayment wouldn't be anywhere near close to the $250k quoted. Then again not factoring in any downpayment - which at least you get to keep as equity - or closing costs - which you won't ever see again and will have to ante up if you ever trade up/sell is also wrong.

Posted by: Anonymous at March 29, 2007 12:06 PM

Of course renting means that you are at the mercy of your landlord in terms of them raising your rent to cover their costs or selling their place to another owner who doesn't want tenants or a whole myriad of other scenarios. My in-laws are people who subscribed to the rent forever credo and they are now in their 60s, moving again. No thanks. Coming from a family where renting is generally abhorred, I just can't see it. Even considering that the cost of owing a home in brownstone or most other brooklyn is at the ceiling of prohibitive right now.

Posted by: jdhs91 at March 29, 2007 12:12 PM

Annonymous you are right I figured the downpayment wrong it should be $190K ($165+25 closing) - I am not figuring 10% downpayment b/c that generally means a higher mortgage cost (your condo may accept 10% down but the bank generally doesnt)

--which means that at 5% you are losing about $800mo in interest which changes the calculation to $4500 a month to own or subtracting the equity as well= $3800.

If you are comparing this to a $3000mo rental it is (very conservatively) almost 10K a year (after taxes) more to own then to rent.

Sorry for the bad math above - but point is still the same.

Posted by: David at March 29, 2007 12:27 PM

JoshK,

Again, I'm comparing apples to apples. Not putting a downpayment on your purchased home would cause you to pay PMI and maybe a higher interest rate. Therefore, if you compare apples to apples, meaning the same monthly outflow! (without getting technical) then you won't be able to say renting "TODAY" makes more sense than buying a comparable space.

Posted by: Anonymous at March 29, 2007 12:29 PM

And your point is correct only to an extent - as an owner you give up the LL risk (which may be ameliorated in rent stabilized apartments) and gain other risks - first and foremost is market risk - if you buy and the prices fall when you need to sell the cost of ownership could be exponentially higher then renting; you also have repair risks (which can also be astronomical in a private brownstone); risk of assessments, risk of tax increases, fuel cost increases (most rentals come with heat), not to mention being responsible for some or all maintainace (depending if it is Coop, Condo or private house).

Everything has its pluses and minuses and people have to objectively look at all of them. Renting can be a very sound financial as well as lifestyle choice for many people, and ownin can be potentially a financial nightmare. It all depends....

Posted by: David at March 29, 2007 12:36 PM

David,

You're trying to be a little too sophisticated for your own good. Apples to Apples my friend.

If that's a 3 family brownstone you bought you're getting no less than $2,700 in monthly rental income.

But if we want to make a case of it, (that I doubt other bloggers care to) we can.

So if you're talking about buying 3 family brownstone in Bed-Stuy vs. renting a 2 bedroom duplex in a bed-stuy brownstone. I still maintain the numbers will not be such that it prohibits you from buying as opposed to your ability to rent that identical space.

Posted by: Anonymous at March 29, 2007 12:52 PM

My point is not to make a sweeping statement. Renting is better than Buying... or Buying is better than renting.

My point is to say, Apples to Apples... you have to figure the numbers and determine which is better for YOU!

The previous poster makes that point by comparing a 2 br. Duplex in a Brownstone vs. Buying the 3 family browstone, collecting the rental income, paying the tax, mntnce, ins, etc. Which one makes for the better choice? I don't know..

Maybe you're a hedge-fund manager and you know for a fact you can achieve a 25% return on your money. If that's the case, it wouldn't make sense to buy a house when you can simply rent and invest the cash in your equity long/short fund.

Posted by: NewStoner at March 29, 2007 12:59 PM

For what it's worth, I got a good deal on a studio apartment in Clinton Hill a few years back and am paying $800 a month for maint and mortgage. If you can find a good deal on a place and if you can secure a good rate (I got 4.75%!), it's a no-brainer to buy.

Posted by: BrooklynZoo at March 29, 2007 1:04 PM

you know for a fact you can make 25%? fantastic! go ahead and buy anything you'd like! also, enjoy your powers of flight, invisibility and time travel! you are one awesome hedge fund manager!

Posted by: Anonymous at March 29, 2007 1:06 PM

brownstone? for 650? right.

Posted by: gpt at March 29, 2007 1:08 PM

Newstoner - I agree that it all depends I was simply referring to your comment @ 11:07 above:

"So, in today's low interest rate environment, you'll be hard pressed to find an apartment that makes more sense to rent, than a comparable co-op,condo, or brownstone w/ tenants of the same size."

I will leave out the Brownstone w/ tenants senario because introduces too many variables but otherwise I believe this comment is generally wrong. In today's high price enviroment you'd be hard pressed to find an apartment where it wouldnt make more financial sense to rent a comparable apartment.

Posted by: David at March 29, 2007 1:09 PM

i love all these absurd math calculations. 20% of 650K is 130K. not 165.

and closing costs will not be 25K. my closing costs were about 3,000. granted half the price we are speaking of but still...you do the math.

and the whole renting vs. buying thing is not so easy to sum up in these calculations. i just recently in the past year have bought my first apartment and the level of satisfaction involved for some people that ownership provides is not able to be calculated.

to know that in a city with such limited space, to know that you own a little piece in which you are able to do what you want and not be at the mercy of the many greedy and inadequate landlords in the city, in my opinion far outweigh anything i've ever experienced renting a property.

sure, i know we're talking about the money part of it, but not everyone looks at buying a home as trying to win the lottery. i look at it as my own tiny slice if heaven in what i consider the best city to possibly own in.

not to mention a relative deal compared with other cities of new york's stature.

Posted by: anon at March 29, 2007 2:12 PM

Here are 2 Brownstones for less that $720. They do exist. So it's not such a stretch

http://corcoran.com/property/listing.aspx?Region=NYC&ListingID=948512

http://corcoran.com/property/listing.aspx?Region=NYC&ListingID=934433

Posted by: Anonymous at March 29, 2007 3:12 PM

Anon @2:12 I am glad that your housing decisions are based on the psycological factors; because clearly you dont know anything about real estate or financing. New York City has 2.175% mortgage recording tax which would be over $14,000 alone, then you are going to have Bank fees, attorney fees, title searches etc...

And the downpayment isnt = 20% of the mortgage its 20% of the purchase price.

Posted by: Anonymous at March 29, 2007 3:32 PM

Can somebody PLEASE tell me where they are offering the $3K mortgage closings? I mean REALLY.... Don't hold out!!!!!

Posted by: NewStoner at March 29, 2007 3:38 PM

not sure why the need for all the nasty comments once again. i'm telling you my closing costs were 3,000. tops. i think i'd know. just bought the place in november. 30 year mortgage through citibank.

maybe they are more on a condo vs a co-op.

your ridiculous insults do not make me any less happy with buying a place in brooklyn.

and i'm not in the real estate or financing profession. i'm a musician. so i'll leave it to you all to fight out the numbers. now i know why i prefer to have friends who don't work in your professions.

assholes.

Posted by: anon at March 29, 2007 3:45 PM

And I prefer people who dont call other peoples posts/math "absurd" when they don't know what the hell they are talking about.

Welcome to Brooklyn

Posted by: David at March 29, 2007 4:06 PM

Seriously, calm it down people.

Co-op closing costs are less than condo/home closing costs.

Posted by: BrooklynZoo at March 29, 2007 4:11 PM

conversations like this are exactly what is ruining new york and brooklyn.

some of you wise ass knowitall finance types should realize that the reason brooklyn was an interesting destination in the first place was because of the creative and working class types who moved in and lived here when no one else would.

you should ACTUALLY be welcoming this person instead of alienating them and hoping that another wallstreeter will move in and add yet another starbucks to the hood.

Posted by: jm at March 29, 2007 4:12 PM

I find this conversation disturbing. First of all, granted not everyone needs to "own" their home, but everyone needs housing. Whether you rent or own, there is a need for housing.

Ideally you get the most secure housing possible. By secure I don't mean a safe neighborhood, I mean a housing situation that has a minimal risk of eviction. The problem with sub-prime mortgages as they relate to people with with faulty credit or low incomes is that they increase the risk involved in housing. Since employment risks at the lower end of the job market are higher already, by selling or promoting high risk mortgages, you are compounding the risk of poverty and homelessness in the event of some personal crisis - job loss, illness, etc. Increased employment volatility, more pressure for personal insurance against health crises, reductions in social transfers, and sub-prime mortgages and other 'innovative' financing contribute to a general privatization of risk. For people of means, this is not necessarily a problem, since you are effectively self-insured against crisis by your economic situation. For lower income people, already vulnerable, sub-prime mortgages are one more layer of vulnerability.

Posted by: ex-Redhooky at March 29, 2007 8:01 PM

"Maybe Subprime Loans Aren't Pure Evil"

True. They're only 98% Evil. The other 2% are Greed and Stupidity.

Posted by: Desk Sgt. at March 29, 2007 9:24 PM

how is a subprime loan evil if its all you can get? should all of us subprime types admit defeat and never start earning equity on our homes, and just throw $2000 a month down the drain on rent for the next two years? because if you want to live like a human being in a decent neighborhood, thats what it costs (at least 1700). so we should just not try because theres a chance we wont be able to afford our home at some point in the future. unless im mistake, all the things that may make you unable to repay your lender would also make you unable to pay your rent. give me a break.

Posted by: david James Fox at March 30, 2007 5:03 AM

how is a subprime loan evil if its all you can get? should all of us subprime types admit defeat and never start earning equity on our homes, and just throw $2000 a month down the drain on rent for the next two years? because if you want to live like a human being in a decent neighborhood, thats what it costs (at least 1700). so we should just not try because theres a chance we wont be able to afford our home at some point in the future. unless im mistaken, all the things that may make you unable to repay your lender would also make you unable to pay your rent. give me a break.

Posted by: david James Fox at March 30, 2007 5:03 AM

I am completely baffled by the nonsense some of you are spouting.

1. If I am a lender, not a predatory lender... just a lender, and I'm evaluating the loan application of a person with a very low credit score, should I just loan him/her the money at a normal prime rate "just because"? or should I offset the inherent risk of default by charging a higher premium?

2. If I am a borrower, and I treat bills like the birthday collection plate that comes around the office. "I'll contribute next time" or I'm a borrower, that just so happened to get caught in a bind a couple times... DO I expect that I can get a prime mortgage rate like all the folks that pay their bills on time? NO.

Sub-prime loans are not the evil. Predatory lending yes, sub-prime... NO.

Low income & poor credit ratings are NOT synonymous. I know you folk would LIKE it to be, but it's not. There are folk making well over 6 figures, that have credit scores below 640.

Subprime mortgage are more damaging to the lenders that originate and syndicate them and the investors that subsequently invest in them.

Posted by: Anonymous at March 30, 2007 10:35 AM

http://cartoonbox.slate.com/hottopic/?image=6&topicid=154

Posted by: ex-Redhooky at March 30, 2007 7:18 PM

« Thursday Links Sunset Park One Step Closer to Rezoning »

March 29, 2007

Maybe Subprime Loans Aren't Pure Evil

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