Sub-Prime Submarines

It looks like the lax standards of the credit industry are catching up with them. How lax are their standards exactly?

The Center for Responsible Lending laid out the gory details in its December 2006 report "Losing Ground: Foreclosures in the sub-prime market and their cost to homeowners" According to the report, more than 50 percent of sub-prime loans are underwritten using less than full documentation. A subsequent review of a sample of these loans showed that 90 percent of borrowers inflated their incomes and 60 percent of the borrowers inflated their incomes by more than 50 percent.

Yikes. But that's just a small part of the market, right?

The delinquency rate on sub-prime mortgages is now above 10 percent. With sub-prime mortgages comprising 23 percent of mortgage originations in 2006, the math is ugly and getting worse. Eventually, the CRL projects that 19 percent of sub-prime mortgages originated during the past two years will default with 2.2 million sub-prime households losing their homes and suffering monetary losses of $164 billion.

This mass of foreclosures would add to housing inventory that is already at near-record levels. That in turn would push down prices. These falling prices, together with tightening credit standards, would make re-financing the exploding ARMs that are maturing this year problematic. With payments rising dramatically and households falling into negative equity, the temptation to walk away is very real.

It could get ugly.