Consumers’ Defaulted Subprime Home Loans Difficult to Restructure

Many thousands of California consumers have bought houses–or refinanced them–using “subprime” loans. Subprime loans are offered at higher than market rates to people with impaired credit. Often these loans are structured with little or no money down. Often the mortgage rate is adjustable, beginning with an attractively low interest rate that increases as the loan ages. Both the consumer and the lender essentially make a bet that house prices will continue to climb.

If they win the bet, then the consumer builds equity in the house just because the house’s value increases, not because the consumer pays down the loan. The consumer might be able to discontinue private mortgage insurance. It’s a win-win situation.

The problem is that house prices have been slumping in most places. According to an article in USA Today, a whopping 14.4% of adjustable-rate subprime loans are currently delinquent. Consumers trying to deal with those delinquencies and keep their houses out of foreclosure are facing real difficulties because most U.S. mortgages are now put into trusts, repackaged as bonds and sold to market investors. That means the consumer can no longer deal with Home Town Savings and Loan, but must negotiate with a lender that could have multiple security instruments with different terms that all impact the consumer’s loan.

It’s a huge problem for consumers. The Federal Reserve, as well as state and federal lawmakers, have all been looking for a solution to the default problem because no one wants to see consumers lose their homes. We shouldn’t expect a silver bullet or a uniform remedy, however, because the issue is so complex.

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