"Here Today, Gone Tomorrow: The Impact of Subprime Foreclosures on African-American and Latino Communities,"by Delvin Davis May/June 2007 issue of Poverty & Race
When a broker named Chad called Delores King about refinancing her home two years ago, she did not suspect it was the beginning of her downward spiral toward foreclosure. Ms. King, an African-American retired office administrator and a resident of Chicago’s South Side, was living on a fixed income of around $1,200 a month. She had a $140,000 mortgage on her home, with monthly payments of $798. But Chad, coming across as a trusted friend and advisor, convinced Ms. King to refinance into an adjustable rate mortgage (ARM) that, while producing an immediate reduction in her monthly payments, exploded to $1,488 after the initial teaser rate expired.
“I have refinanced before, but I’ve never seen anything like this,” King testified to the U.S. Senate Committee on Banking, Housing, and Urban Affairs last March. “It should be against the law for a bank to make a loan knowing that it will be impossible for the person to pay it back and they will lose their home.”
Unfortunately, Ms. King’s experience has become more and more commonplace over the past few years. Subprime lending has broken loan origination records recently with the proliferation of “exploding ARM” loan products—loans that promise a low initial interest rate, only to become drastically unaffordable within a few years once the rates adjust. Ms. King’s story illustrates much of what has gone wrong with the subprime mortgage industry: lax underwriting standards, unsustainable and unreasonable loan terms, as well as broker dealings that are detrimental to the borrower’s best interest. All of these factors have contributed to the foreclosure crisis in African-American and Latino communities.
With home value appreciation rates slowing down, borrowers who are behind on mortgage payments often do not have the equity to refinance their way out of an impending foreclosure situation. The Center for Responsible Lending’s Dec. 2006 report, “Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners,” estimates that one in every five subprime loans made during 2005 and 2006 will end with the borrower losing his or her home through foreclosure. This is the highest foreclosure rate ever seen in the modern mortgage market, and it will have a significant impact on communities of color, which receive a disproportionate number of subprime loans.
As Wade Henderson of the Leadership Conference on Civil Rights said upon the release of our “Losing Ground” study, “Low-wealth communities have the most to gain from homeownership, but they also have the most to lose from foreclosures.”
Existing Wealth and Income Disparities
People of color experience well-documented disparities in income, wealth, employment and credit. The disparities that exist today were born in slavery, Jim Crow segregation and institutional discrimination, which have forced people of color to start the race to homeownership and wealth-building two steps behind and without the benefit of inherited family wealth.
African Americans and Latinos have taken many strides just in the past few decades, but the lingering economic effects of historical oppression are still evident today:
Disparities in wealth and income translate to disparities in the housing market, reflecting how communities of color are vulnerable to the risks of subprime lending:
Reckless Lending Practices
Abuses in the subprime market have made foreclosure more likely. Brokers are paid on commission and yield spread premiums have become common in the subprime market. These kickbacks from lenders to brokers for funneling business their way make it more profitable for a broker to steer a borrower toward a loan with a higher interest rate than the borrower qualifies for. Consequently, even borrowers with decent credit are signed up for expensive subprime loans. A study by Freddie Mac confirmed that between 35-50% of subprime borrowers could qualify for prime credit.
Exploding and exotic subprime ARMs are increasingly causing foreclosures. When the rates reset on a two-year or three-year adjustable rate mortgage, monthly payments can jump 30-50% beyond the initial payments, pushing these payments out of range of a family’s monthly budget. This is especially the case when lenders and brokers use unverified stated income practices that allow them to fictionally state any income on the loan application that will justify making the loan. Over 70% of all subprime loans are variations of these exploding ARMs, and over 40% of subprime loans use stated income to verify a borrower’s ability to repay.
To compound the problem, not only are these loans originated without regard for the borrower’s ability to afford the fully indexed rates, monthly payments are not guaranteed to account for escrow amounts, such as property tax and insurance payments. This can pressure an already cash-strapped family to refinance, losing more equity out of their home, just to stay current on property taxes. Over $600 billion in loans will have interest rate resets within the next two years; things will get worse for subprime borrowers before they get better.
Higher levels of debt also create pressure on homeowners to tap into their home equity through repeated refinancing, and this makes non-white homeowners more vulnerable to the push-marketing tactics of subprime brokers and lenders. The median value of debt carried by whites in 2004 was 49% of their median family net worth, but for non-whites, debt was 123% of their family net worth.
There is evidence that systemic discrimination and exploitation by unscrupulous lenders exacerbates the income and wealth disadvantages for people of color. According to research by the California National Organization for Women, real estate brokers discriminated against African-Americans in 46-59% of their interactions.
Tavis Smiley’s recent book, The Covenant with Black America, further details several of these discriminatory practices. It documents unfair treatment by brokers and mortgage-lending institutions that further maneuver people of color into subprime products. He finds that people of color are more likely to be:
The Homeownership Ideal
African Americans and Latinos have the lowest homeownership rates in the nation—under 50%, compared to 76% for whites. President Bush set a goal of creating new homeownership for over 5 million people of color by the end of this decade. This is a worthy goal, but our broken subprime credit system must be repaired before homeownership can truly become the wealth-building vehicle it was intended to be.
Subprime mortgage credit has been promoted as key to bolstering homeownership for people of color. But the mortgage market is currently experiencing some of the highest foreclosure rates the country has ever seen, largely due to reckless subprime lending practices. Without a healthy, fair and affordable mortgage market, the gains of homeownership for people of color will drain away through foreclosure and equity-stripping.
The Center for Responsible Lending has found that subprime lending over the last nine years will result in more foreclosures than it will create new first-time homeowners. This net loss in homeownership holds especially true for African-American and Latino borrowers. For subprime originations made in 2005, among African Americans and Latinos, we estimate that there will be 84,000 more foreclosures than there will be first-time homeowners.
A recent case study examining Option One subprime ARMs in Mecklenburg County, NC reveals that three out of every four subprime ARMs are refinanced into another subprime loan product. In the end, more of the loans in this sample ended up in foreclosure (8.5%) than in prime fixed-rate loans (7.5%).
Once on the subprime treadmill, it is extremely hard to finance your way off of it. The home losership phenomenon is quite discouraging for people who have believed that subprime lending would be a stepping stone to prime market credit, sustainable homeownership and eventually wealth creation.
Impact on Communities
The effects of foreclosures on the overall community have also proved to be problematic. Inner-city and high racial and ethnic minority neighborhoods are peppered with a disproportionate number of foreclosures. According to a Homeownership Preservation Foundation study on Chicago-area foreclosures, every foreclosure that occurs in a city can cost municipal governments over $30,000 in lost property taxes and property recovery costs. And when one home forecloses, all other homes on the block lose about 1.5% of their value.
The HUD Office of Policy Development and Research has found that neighborhoods with high homeownership rates tend to be safer, and residents are usually more likely to participate in community organizations, to vote, and to have higher self-esteem and satisfaction with life. Excessive and unnecessary foreclosures not only destroy these social benefits, they make it nearly impossible to keep neighborhoods healthy and intact.
Eight percent of Latinos and 10% of African Americans are at risk of losing their homes. This could mean the largest loss of wealth for African-American and Latino families in the nation’s history. To quell the tidal wave of foreclosures across the nation, the lending industry, federal regulators, Wall Street and Congress must all take action.
Along with the Leadership Conference on Civil Rights, NAACP, National Council of La Raza, and the National Fair Housing Alliance, the Center for Responsible Lending advocates an immediate six-month moratorium on all subprime foreclosures. A moratorium would slow the snowballing crisis long enough for policymakers, advocates, homeowners and the industry to strategize about how to fix the problems and allow families to stay in their homes, as well as saving lenders some of the losses associated with foreclosure.
Subprime lenders should offer work-out plans and loan modifications for existing and future borrowers facing foreclosure. Loan servicers should be aggressive in helping homeowners avoid foreclosures. Servicers have the ability to modify a loan if there is a reasonable likelihood of foreclosure, and should offer these modifications without unnecessary extra fees.
Federal regulators should ensure that their proposal for guidance on nontraditional mortgages—establishing underwriting standards to help curtail defaults— is adopted. The industry has failed to police itself, and it is imperative that federal regulators exercise proper oversight and protect all future borrowers from abusive products. Wall Street investors benefited from buying pools of subprime mortgages securitized by exploding ARMs; they too must take responsibility for having contributed to the subprime crisis.
Congress has the authority and the responsibility to deal with this national foreclosure crisis. The first order of business is to amend the bankruptcy code so that families who are already in foreclosure crisis have the ability to save their homes when they must file for bankruptcy. As it stands, bankruptcy courts cannot modify the terms of owner-occupied residential mortgages. The current foreclosure crisis makes a strong case that the courts need to have that power.
The bankruptcy code should be further amended to eliminate a counseling requirement that makes the process too slow to help; to prohibit exorbitant interest rates and fees levied during the bankruptcy period; and to eliminate mandatory arbitration clauses, which deny homeowners their right to take grievances to a court of law.
In addition, Congress should impose a fiduciary duty on brokers to ensure that they are working in their clients’ best interest. Legislation should eliminate broker kickbacks from lenders, which give brokers an incentive to place borrowers into loans they cannot afford. Abusive prepayment penalties and other practices that are designed to strip equity from the borrower should be eliminated. Subprime lenders should be required to escrow for taxes and insurance and to verify the borrower’s income, practices that are routine in the prime market. The guiding principle for lending reform should be that no borrower will receive a loan he or she cannot afford.
It will take participation from all parties to stem the tide of foreclosures coming our way, but it is truly in everyone’s best interest to participate. If the market is left to correct itself without intervention, millions of families will be displaced by foreclosures in the next few years. If we act now, there is a chance we can help those who are already in the foreclosure process. We can prevent more stories like that of Ms. King. And we can eliminate another obstacle in the struggle of people of color to achieve economic equality.
Delvin Davis is a Research Associate at the Center for Responsible Lending in Durhan, NC, where he investigates both the impacts of, and remedies to, predatory lending in different lending markets. firstname.lastname@example.org
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