From the Boston Globe:
If it looks like a bubble, smells like a bubble, and tastes like a bubble, it must be a bubble.
Or is it?
The smart money now says the US housing market, overall, is not in a bubble. But at least one part of the market certainly looks pretty frothy — the mushrooming “subprime” mortgage market for borrowers who can’t get standard loans. That bubble seems to be bursting.
Subprime lending rose from $150 billion in 2000 to $650 billion at the end of 2005, and now accounts for more than 20 percent of the mortgage market, the government says.
In theory, subprime loans can be good. In exchange for higher-than-usual interest rates, loans are offered to people who otherwise could not buy homes because of low incomes or tarnished credit.
But studies have shown that mortgage brokers and other lenders often press subprime loans on borrowers who actually could qualify for conventional mortgages with lower interest rates. Why? Because the lenders pay the brokers bigger commissions on subprime loans.
To make matters worse, about 80 percent of subprime loans carry interest rates that adjust every 12 months, starting after the loan has been held for two years. Many people who got these loans in 2005 are now seeing their monthly payments jump 30 to 50 percent.
Finally, about 70 percent of subprime loans, unlike conventional ones, carry prepayment penalties that can trap borrowers by charging thousands of dollars if they refinance within the first three to five years.
Some consumer groups have proposed a “suitability standard” to require brokers to put the borrower’s interests first when recommending a loan. Stockbrokers work under such a rule and can be banned from the business for violations. Another remedy would be to require better disclosure of mortgage brokers’ commissions, so borrowers can tell if they’re being pushed toward a loan that’s more profitable for the broker than others.
Of course, borrowers need to do their part. If you are offered a subprime loan ask lots of questions. Is there a prepayment penalty? What’s the highest rate the loan could go to in the future? Are there other loans you can qualify for?