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A Case for Subprime Loans from the Texas A&M Real Estate Center

Just the mention of subprime loans these days draws criticism from the halls of the Capitol to the California coast. There is no denying that foreclosure rates, many of which fall under the category of subprime mortgages, are rising and likely haven not yet hit a top.

U.S. foreclosure filings totaled 179,599 in July, 93% higher than in July 2006, according to data compiled by RealtyTrac. Five states -- California, Florida, Michigan, Ohio and Georgia -- accounted for more than half of the nation's July foreclosure filings, said James Saccacio, chief executive of Irvine, Calif.-based RealtyTrac. But Nevada came in with the nation's highest state foreclosure rate for the seventh month in a row -- one foreclosure filing for every 199 households in July, a rate more than three times the national average.

Despite the sobering statistics, some real estate experts are willing to go to bat for subprime loans, which are targeted at higher-risk consumers with less-than-perfect credit scores and for whom, homeownership might once have seemed out of the question. Ridding the real estate market of this loan structure will mean that so-called working-class citizens will be denied a major investment vehicle - a home.

"Many state, local and federal housing programs were created to increase homeownership, but most never reached the number of potential homeowners that the subprime market reached," says Dr. James Gaines, research economist at the Real Estate Center at Texas A&M University. "The private sector found a way to make loans to low-credit, previously unfinanceable households. While this effort was spurred by profit, not altruism, the effect on homeownership throughout the country was nevertheless profound."

Among Real Estate Center findings: substantially reduced mortgage interest rates and relaxed lending standards caused U.S. homeownership to increase from 64 percent in 1995 to more than 69 percent in 2006, an unprecedented jump; since 1998, subprime loans have increased from less than 2 percent to more than 14 percent of the total market, and they are estimated to make up 25 percent or more of all mortgage loans originated since 2003; the current national foreclosure rate on subprime mortgages is around 4.5 percent, which will probably increase during the next year.

Dr. Gaines argues that regulators and lawmakers, rather than do away with a mortgage vehicle that has put many low-income people in homes, should crack down on residential lending practices that have gone from being merely aggressive to being predatory and illegal.

For example, he says, some loan originators steer borrowers into loans that are more expensive and carry a higher risk than necessary, or provide preclosing good faith cost estimates that are so complicated that borrowers cannot understand them. Borrowers are sometimes told not to worry about individual costs and fees because they will be rolled into the loan.

"It is imperative that the residential mortgage market operate efficiently and with clear, defined limits," he says. "The penalty for exceeding or disregarding the limits should be severe."

Rachel Koning Beals has written about credit, real estate, personal finance and investing for 12 years.

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