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It’s time to debunk some myths about subprime loans and borrowers.

Remember when our subprime loan problems were contained?

Researchers for the Cleveland Fed, Kent Cherry and Yuliya Demyanyk write Subprime mortgages: Myths and reality

Myth: Subprime mortgages went only to borrowers with impaired credit

…The reality is that subprime mortgages went to all kinds of borrowers, not only those with impaired credit. The myth that subprime loans went only to those with bad credit arises from overlooking the complexity of the subprime mortgage market and the fact that subprime mortgages are defined in a number of ways – not just by the credit quality of borrowers.

Myth: Subprime mortgages promoted homeownership

…The number of such defaults outweighs the number of first-time homebuyers with subprime mortgages, negating the homeownership promotion component of subprime lending. In short, borrowers really become “homeowners” if they can hold on to their home, and this was not occurring during the subprime years.

Myth: Declines in mortgage underwriting standards triggered the subprime crisis

…Actually, the criteria that are associated with larger default rates, such as debt-to-income or loan-to-value ratios, were, on average, worsening a bit every year from 2001 to 2007. However, these underwriting metrics in 2006 and 2007 were not sufficiently different from prior years to explain the nearly 100% increase in default rates just before the crisis.

Myth: Subprime mortgages failed because people used homes as ATMs

…Mortgages that were originated for refinancing actually performed better than mortgages originated solely to buy a home (comparing mortgages of the same age and origination year).

Myth: Subprime mortgages failed because of mortgage rate resets

In short, fixed-rate mortgages showed as many signs of distress as adjustable-rate mortgages. These signs for both types of mortgage were there at the same time; it is not correct to conclude that FRMs started facing larger foreclosure rates after the crisis was initiated by the ARMs. Also, ARM loans showed high default rates long before resets were scheduled, which indicates that poor performance of these mortgages cannot be explained simply by changing interest rates alone.

Myth: Subprime borrowers with hybrid mortgages were offered (low) “teaser rates”

…the average subprime hybrid mortgage rates at origination were in the 7.3%–9.7% range for the years 2001–2007, compared to average prime hybrid mortgage rates at origination of around 2–3%. The subprime figures are hardly “teaser rates,” even if they were lower than those on subprime fixed-rate mortgages.

There is much more in their report and it is worth the read.

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