Sub-prime Mortgages Archives
Sub-prime Mortgages

Sub-prime loan practices began in the mid-1980s as lawmakers sought to increase housing opportunities. Prior to this, many Americans were unable to purchase a home due to credit scores below 550. Census data compiled by the Federal Reserve shows that over half of the failed mortgage payments were African-American families, while only ten percent of successful prime mortgage applicants were African-American.

In an effort to equalize access to housing, Congress adopted the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) in 1980 to preempt state interest rate caps. In 1982, the Alternative Mortgage Transaction Parity Act ( (AMPTA) [PDF] introduced variable interest rates and balloon payments. These were the foundation of subprime lending laws; additions and changes emerged in response to economic downturns in the late 1990’s and early 2000’s. The Federal Reserve estimates [PDF] these lending practices were six times more likely to fail.

Throughout the mid-1990s, sub-prime loans composed up to 8.8% of the housing market. With the turn of the century, lending practices were expanded to applicants with credit scores up to 600. Middle class borrowers began to use predatory loans on a large scale. Common loans featured relatively volatile adjustable rates, pre-payment penalties and additional up-front fees on a wide scale. Many features were decided by factors such as race, not credit scores.

By the late 1990s, many of the first lending institutions failed and were purchased by growing banks, including JP Morgan Chase and Bank of America. During that transition, many of the sub-prime loans were aggregated with higher grade loans already owned by the successor banks. The riskier loans, packaged with more traditional loans, eventually failed at the height of the “housing bubble,” increasing the cost to all loans regardless of origin.

The “housing bubble” started taking shape in the early 2000s, as interest rates fell to 40-year lows and sub-prime mortgage practices became more popular than ever. Effectively, borrowers in the early 2000s had access to loans that were two to three times the amount of what they would have had access to in the 1980s and 1990s at interest rates that were lower than that time period as well. Variable interest rates on these mortgages eventually made them more expensive than consumer credit cards for many borrowers.

When the bubble popped, it was for the same reasons that most of the first sub-prime mortgage companies failed – these are intentionally risky loans. The difference between the 1990s setbacks and the 2008 market crash was in volume and diversity. The families affected by predatory practices in the 1990s were more likely to be lower-income and a financial setback did not affect other investments. However, the families affected by later loans were more likely to be lower and middle class, and a home foreclosure affected other investments and created a domino effect across industries. The number of sub-prime loans in 2008 was more than twelve times that of the 1990s, and the resulting financial crisis reflected such proportions.