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Subprime lending lies at the rotten core of the crisis

Subprime lending has triggered a global financial crisis, but it remains misunderstood. Here are some basic facts, culled from an upcoming report on abandoned housing by the Partnership for the Public Good.

Subprime loans are high-cost loans, ostensibly designed for people with less than "prime" credit. In reality, mortgage brokers and lenders often sell subprime loans to people with good credit.

Subprime lending grew very fast: from 7 percent of home loans in 2000 to 21 percent in 2006, creating a $600 billion industry. This explosion was fueled by many factors, including the deregulation of financial services.

Subprime loans include many negative features beyond high rates and fees. Most subprime loans in recent years have come with low teaser rates that reset into expensive adjustable rates after two years. About 70 percent include prepayment penalties that trap borrowers in the loans and prevent them from refinancing affordably if they discover they've been duped. They have been marketed with intensive advertising and high-pressure, often fraudulent, sales techniques designed to prey on elderly and other vulnerable homeowners. Many lenders have broken even today's lax lending laws. Ameriquest paid $325 million, and Household International paid $484 million, to settle predatory lending lawsuits.

Most importantly, subprime lending was never about expanding access to homeownership. Only 38 percent of subprime loans are for home purchase, and only 9 percent go to first-time home buyers. The rest are home equity loans and refinancings. What are home equity loans used for? In 2004, 58 percent went for home improvements and personal spending, and 27 percent went to pay off credit card debt.

Essentially, Americans are pawning their houses -- using them as collateral for expensive, high-risk loans. Thus, subprime lending has decreased homeownership by leading to foreclosures. Homeownership rates for the bottom two-fifths of the income scale dropped from 45.4 percent in 1980 to 42.4 percent in 2005. The Center for Responsible Lending estimates that one out of five subprime loans made in 2006 will end in foreclosure. It calculates that subprime lending has created a net loss of 1 million homeowners.

Buffalo has not escaped the subprime debacle. A 2008 federal study found 9,080 subprime loans in Western New York, of which 22 percent were overdue, 5.5 percent were in foreclosure and 1.9 percent had been foreclosed. The Center for Responsible Lending predicts that 15.6 percent of the subprime loans made in the Buffalo area in 2006 will end in foreclosure.

As the government attempts to repair the credit system, it must begin to regulate subprime lenders just as it regulates banks, and it must strictly limit the ability of lenders to sell credit on unaffordable and exploitative terms.

Sam Magavern teaches in the Affordable Housing Clinic at the University at Buffalo Law School and is a founder of the Partnership for the Public Good.

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