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Subprime Myths Debunked – Part 1

The Federal Reserve Bank of Cleveland has posted an article that puts forth ten common misconceptions, or myths, about subprime mortgages and the current financial crisis.  We'll take a look at each in two posts, the first five here:

  1. Subprime mortgages went only to borrowers with impaired credit - the credit score of the borrower was one criteria that could label a loan as "subprime."  However, there are many more, such as the type of loan, the lender, and the pool of mortgages in which a loan was grouped for securitization.  Borrowers with very good credit scores could still end up with a loan labeled as "subprime."
  2. Subprime mortgages promoted homeownership - In the period 2000 to 2006, more than a million first time homebuyers purchased with a subprime mortgage, but defaults have now negated this increase in homeownership.
  3.  Declines in home values caused the subprime crisis in the United States - The quality of newly originated mortgages was declining from 2001 through 2007, beginning long before price declines began.  The price declines only helped to reveal problem mortgages.
  4. Declines in mortgage underwriting standards triggered the subprime crisis - Though debt-to-income and loan-to-value ratios were gradually worsening between 2001 and 2007, there were not great changes in underwriting standards during the period, certainly not in the same magnitude as the huge increase in defaults.
  5. Subprime mortgages failed because people used homes as ATMs - Actual data shows that the default rate on cash-out and home equity lines of credit mortgages have been significantly lower than for mortgages originated for the purchase of a home.

My next post will cover the last five of the "myths" as characterized by the Cleveland Fed.  There are a couple of interesting interpretations in the group.

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