Some loan setups raise foreclosure odds

Deseret News (Salt Lake City), Jan 27, 2005 by Dave Anderton Deseret Morning News

Home loans containing prepayment penalties or balloon payoffs are more likely to land in foreclosure, according to a new study.

The study, by the University of North Carolina at Chapel Hill, said borrowers with prepayment penalties of three years or longer on subprime home loans faced 20 percent greater odds of foreclosure than borrowers without such penalties.

Borrowers with subprime prepayment penalties of less than three years fared only slightly better, with 16 percent greater odds of foreclosure than borrowers without such fees.

In addition, borrowers with a subprime loan with a balloon payment clause faced 46 percent greater odds of foreclosure than their similarly situated counterparts without such a term.

The study was based on 3.7 million monthly observations on 122,000 first-lien subprime refinanced loans from across the country.

Subprime loans generally carry a higher interest rate and are considered to be a higher credit risk.

The findings could partly explain Utah's high foreclosure rate.

For the three months ended Sept. 30, 2004, the percent of all Utah loans in foreclosure -- including prime, subprime and FHA loans -- was 1.52 percent, tying Utah with West Virginia for the 10th-highest foreclosure rate in the nation, according to the Mortgage Bankers Association of America.

Michael Stegman, director of the Center for Community Capitalism at UNC and one of the authors of the study, said subprime borrowers, policymakers and the investment community should be concerned.

"Investors should be concerned because these foreclosures reflect inefficiencies in the origination of subprime refinanced loans," Stegman said. "Policymakers should be concerned with our findings because predatory lending is draining homeowner equity and increasing foreclosures and home losses, especially in minority communities, just at the time that national housing policy is attempting to close the minority homeownership gap."

Keith Ernst, senior policy counsel for the Center for Responsible Lending, said one in five home loans originated in the United States today is a subprime loan. Borrowers, he said, pay $2.3 billion in subprime, prepayment penalty fees each year.

"Unfortunately, the growth of the subprime market has corresponded with an increase in abusive lending that has become a crisis for American families," Ernst said. "Losing a home is a traumatic event for individual families and entire communities. Unfortunately, foreclosures on subprime refinance mortgages are epidemic. One in five subprime refinance loans ends up in foreclosure. That's 10 times the rate for mortgages in the prime market."

Nina Simon, senior attorney with the American Association of Retired Persons Foundation Litigation, said the UNC study confirms what she always has suspected.

"This practice area was thrust upon us in the early 1990s when we were first presented with a rash of foreclosures involving older homeowners who had been victimized by predatory lending practices," Simon said. "Today most mortgage loans are rapidly sold into the secondary market, allowing lenders to leverage funds and originate a large number of loans without significant capital. . . . Indeed, these very factors may also explain why market participants either encourage or are indifferent to the increased risk of foreclosure engendered by the loan characteristics studied by UNC researchers."

E-mail: danderton@desnews.com