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Subprime Mortgage Lending and Older Borrowers

Introduction

The subprime (that is, non-prime or below "A" rated credit) mortgage lending industry has grown significantly in recent years, expanding from a $35 billion industry in 1994 into a $140 billion industry in 2000 (Figure 1).

Subprime mortgages currently represent 13 percent of total mortgage originations, an increase from 4 percent of originations in 1994 and 12 percent in 1999.

Most subprime lenders are mortgage or finance companies, although lenders can also be thrifts, banks, or affiliates of banks. Historically, subprime loans have been made to borrowers with blemished (or non-existent) credit records,and the borrower is charged a higher fee to compensate for the greater risk of delinquency and the higher costs of loan servicing and collection.

There is increasing concern about the growth in subprime lending for several reasons. First, there is growing evidence that many borrowers who qualified for less costly loans received subprime loans. One study found that between 10 percent and 35 percent of "A-" subprime borrowers qualified for "A" mortgages, but received and were paying for more expensive subprime mortgages.

Second, the percentage of foreclosures associated with subprime mortgages appears to be increasing. A recent study in Chicago found that 25 percent of foreclosures in 1998 involved borrowers holding mortgages with high and extremely high interest rates, up from 10 percent in 1993. Similarly, in Atlanta, while the overall volume of foreclosures declined by 7 percent between 1996 and 1999, the volume of foreclosures started by subprime lenders grew by 232 percent.

Third, there is growing evidence of predatory lending practices in the subprime lending market. Practices such as charging exorbitant fees and interest rates often occur when subprime borrowers are unsure about their credit history and loan eligibility, or are unaware of mortgage details (balloon payments and prepayment penalties, for example).

Fourth, specific demographic groups are disproportionately represented among subprime borrowers. Recent analyses of Home Mortgage Disclosure Act (HMDA) data reveal that minorities with incomes similar to non-minorities are significantly more likely to receive a subprime mortgage.

Similarly, there is evidence that older homeowners are being targeted. A recent study found that borrowers 65 years of age or older were 3 times more likely to hold a subprime mortgage than borrowers less than 35 years of age. Figure 2 shows that for borrowers 45 and older, 56 percent of mortgages were subprime, while for borrowers younger than 35, only 12 percent of mortgages were subprime.

Methodology

This Data Digest presents results from a study of 4,342 mortgage borrowers who had acquired first lien mortgages between January 1996 and June 1997. Respondents were asked an extensive array of questions related to their mortgages. Survey responses were matched with lending firms and credit scores. Regression analyses identified financial risk, demographic variables, and a variety of other factors as being significant in the likelihood of a borrower having a subprime mortgage. Analyses conducted for this Data Digest examine older borrowers, and the differences between older prime and subprime borrowers.

Findings

Financial Risk Factors

For two financial risk factors, credit history and loan-to-value (LTV), older subprime borrowers had higher risk than older prime borrowers. Credit History. Figure 3 shows that older borrowers with lower-risk FICO scores (that is, 680 and above) were less likely to hold a subprime mortgage than older borrowers with higher-risk FICO scores. However, 11 percent of older subprime borrowers had lower-risk FICO scores.

Loan-to-Value (LTV)16 Figure 4 shows older borrowers with low LTV ratios (defined as below 80%). Of these older borrowers with low LTV ratios, approximately one-half (48%) had FICO scores of at least 680. While most older borrowers with low LTVs and high FICO scores held prime mortgages (43%), 5 percent held subprime mortgages.

Demographic Factors

Older female and minority (non-white) borrowers were more likely to hold subprime mortgages than were older male and non-minority borrowers. Gender. Older female borrowers held 45 percent of subprime mortgages and only 28 percent of prime mortgages. Ethnicity. Older African-American borrowers held 18 percent of the subprime mortgages and 7 percent of the prime mortgages (Figure 5). Older Hispanic borrowers held 7 percent of the subprime mortgages and only 2 percent of prime mortgages. Conversely, older white borrowers held 68 percent of the subprime mortgages and 85 percent of the prime mortgages.

Additional Factors

Application Hurdles.
Three application hurdles, asking a borrower to pay off debts, turning down a borrower for a mortgage, and asking a borrower to provide additional documentation, were examined. Of older borrowers who had been asked to pay off debts or had been turned down for a mortgage, a higher percentage were subprime borrowers.
Asked to Pay off Debts. Fifty percent of older subprime borrowers were asked to pay off debts compared to 10 percent of older prime borrowers.
Turned Down for a Mortgage. Over one-fourth (26%) of older subprime borrowers had been turned down for a mortgage, compared to 3 percent of older prime borrowers.
Asked to Provide Additional Documentation. More than 4 of 10 older borrowers were asked to provide additional documentation, 41 percent of older subprime borrowers and 46 percent of older prime borrowers.

Life Disruptions.
Older subprime borrowers were more likely to have reported a decrease in income or have major medical expenses/illness "within the past few years" than were older prime borrowers.
Decrease in Income. Over one-third (36%) of older subprime borrowers reported a decrease in income within the past few years, compared to 10 percent of older prime borrowers.
Medical Expenses/Illness. Over one-third (38%) of older subprime borrowers reported either a major medical expense or illness, compared to 13 percent of older prime borrowers.

Search Behavior.
Older subprime borrowers were less likely to report having searched for the best available interest rate than were older prime borrowers. Older subprime borrowers were also more likely to respond to lender advertisements than were older prime borrowers.
Interest Rate Searching. Approximately 6 of 10 (58%) older borrowers holding subprime mortgages reported searching "some" or "a lot" for the lowest interest rate available, compared to 71 percent of older prime borrowers.
Responding to Advertisements. Over one-third (35%) of older subprime borrowers reported having responded to advertisements offering "guaranteed approvals" or "mortgage loans for people who may have had credit problems," compared to 6 percent of prime borrowers.

Financial Perceptions and Mortgage Preparedness.
Older subprime borrowers were less likely than older prime borrowers to feel in control of their finances and less well prepared for taking out a mortgage.
In Control of Finances. Seven percent of older subprime borrowers and 5 percent of prime borrowers either disagreed or strongly disagreed that they were in control of their finances.
Mortgage Preparedness. Older subprime borrowers were less likely to be prepared for taking out a mortgage, as 15 percent of subprime borrowers reported that they were not familiar with common mortgage terminology compared to 4 percent of prime borrowers.

Summary

As expected, financial risk (that is FICO scores and LTV) was a key factor in the likelihood of an older borrower having a subprime or prime mortgage. However, significantly, 11 percent of older borrowers with high FICO scores held subprime mortgages.

In addition to financial risk, a number of other borrower factors differentiated older subprime and prime borrowers. These included key demographic variables, as well as application hurdles (asked to pay off debts and turned down for a mortgage), life disruptions, search behavior, financial perceptions, and the borrower's mortgage preparedness.

Demographic variables suggest that older female and minority borrowers were more likely to hold a subprime mortgage than older male and non-minority borrowers.

Other factors also revealed distinctions between older subprime and prime borrowers: subprime borrowers were more likely to have been turned down for a mortgage, and to have responded to an advertisement offering "guaranteed approvals" or "mortgage loans for people who may have had credit problems."

Footnotes

  1. Analore, A. Inside Mortgage Finance Publications. Personal communication (February 20, 2001).
  2. Inside Mortgage Finance Publications, The Mortgage Market Statistical Annual. Vol. II. (2000).
  3. Includes recent delinquencies, foreclosures, bankruptcies, low credit risk scores, and high debt service to income ratios. See Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision. Expanded Guidance for Subprime Lending Programs. (January 2001). (http://www.fdic.gov)
  4. Williams, R., Nesiba, R., et. al. "The Changing Face of Inequality in Home Mortgage Lending." Notre Dame Sociology Working Paper 2000-11. (November, 2000).
  5. Federal Home Loan Mortgage Corporation. (1996).
  6. NietoGomez, A., et. al. Preying on Neighborhoods: Subprime Mortgage Lending and Chicagoland Foreclosures. National Training and Information Center. (September 1999).
  7. Gruenstein, D. and Herbert, C. Analyzing Trends in Subprime Origination's and Foreclosures: A Case Study of the Atlanta Metro Area. Abt Associates Inc. (February 2000).
  8. U.S. Department of Housing and Urban Development and U.S. Department of Treasury. Curbing Predatory Home Mortgage Lending: A Joint Report. (June 2000).
  9. Ibid.
  10. Lax, H., et. al. Subprime Lending: An Investigation of Economic Efficiency. Unpublished paper (February 2000).
  11. Borrowers were randomly selected from a sample of borrowers generated by DataQuick, a proprietary firm that collects and analyzes mortgage transaction data from county records.
  12. Using industry sources and information from HUD and the Federal Reserve Board, a list of approximately 50 lenders was created representing those institutions that primarily make subprime loans.
  13. For this study, FICO credit scores were identified for the borrowers. FICO refers to the Fair, Isaac and Company credit risk scoring models, the most widely used models to measure consumer credit. This method uses score models and mathematical tables to analyze a borrower's credit history and condense this information into a single numerical value used to predict future credit performance. FICO scores generally range from 300 to 850, with higher scores indicating better credit history.
  14. Due to the small sample of older borrowers, analyses in this Data Digest are limited to cross-tabulations.
  15. Raca, P. "Subprime Lending: Characteristics of Older Borrowers." Presentation to AARP (November 2000). Older borrowers are defined as borrowers 45 years of age and older.
  16. LTV is the principal amount of the loan as a percent of the value of the home. The lower the LTV, the smaller the loan relative to the collateral in the home and, therefore, the lower the risk of the mortgage.

Written by Neal Walters and Sharon Hermanson, AARP Public Policy Institute
March 2001
©2001 AARP
May be copied only for noncommercial purposes and with attribution; permission required for all other purposes.
Public Policy Institute, Public Affairs, AARP, 601 E Street, NW, Washington, DC 20049