Subprime Mortgages: Primer on Current Lending and Foreclosure Issues

Publication Date: March 2007

Publisher: Library of Congress. Congressional Research Service

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Research Area: Banking and finance

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Abstract:

Subprime mortgages are loans extended to borrowers with weak credit profiles. Subprime mortgages entail higher risk of delinquency and default. Recent increases in subprime borrower foreclosures and lender bankruptcies have prompted concerns that some lenders' underwriting guidelines are too loose and that some borrowers may not have fully understood the risks of the mortgage products they chose. Regulatory agencies are revisiting the guidance they provide lenders and are reevaluating required disclosures to consumers. In addition, Congress is holding hearings on the subject and may consider consumer protection legislation.

Subprime foreclosures have reached the highs of the 2000-2001 recession but delinquency rates are not the same across mortgage features. The adjustable interest rate (ARM) feature is currently associated with higher delinquency rates than comparable fixed rate loans. However, the delinquency rate of loans with the negative amortization (NegAm) feature has remained below 1%, the range normally associated with less risky loans. NegAm is a loan that allows a monthly payment less than the current interest on the loan with the remaining interest added to the principal, thus increasing the loan balance.

Financial regulators issued a guidance for alternative mortgage products in October 2006 and issued a proposed statement for subprime lending in March 2007. The guidances require that consumers be given plain-language explanations of the risks of their mortgages. Borrowers must be qualified for mortgage loans based on the ability to repay the loan, not based on speculation about future increases in the value of the real estate collateral. The proposed guidance also seeks to limit payment shock and prepayment penalties. Policymakers are faced with the challenge of balancing the benefits of access to credit against the costs of potential foreclosures.

This report will be updated in the event of significant regulatory or legislative change.