Subprime Spillover

QUICK SUMMARY

In the Center for Responsible Lending's December 2006 study, “Losing Ground,” CRL predicts that millions of American households will lose their homes to foreclosures in the subprime mortgage market.

Background

In our December 2006 study, “Losing Ground,” CRL predicts that millions of American households will lose their homes to foreclosures in the subprime mortgage market.¹ “Losing Ground” focuses on the direct impact of subprime foreclosures, but it does not attempt to quantify how those foreclosures affect neighboring homes and larger communities. In other words, it does not address the “spillover” effect where foreclosures themselves further depress local housing prices. In this report, we estimate how many homes—including families who are paying their mortgage on time—will suffer a decline in property values because of foreclosures in their neighborhoods. We also estimate the monetary value of these losses in terms of lower property value and a reduced tax base for communities.

When a home goes into foreclosure, the negative effects extend beyond individual families losing their homes to surrounding neighbors and the wider community. Published research by Immergluck and Smith (2006) indicates that a foreclosure on a home lowered the price of other nearby single-family homes, on average, by 0.9 percent. They also reported that the downward pressure on housing prices extended to houses that sold within two years of the foreclosure.

Further, Immergluck and Smith found this negative impact was cumulative; that is, each additional foreclosure on the block lowered values an additional 0.9 percent. The impact was even higher in lower-income neighborhoods, where each foreclosure dropped home values by an average of 1.44 percent.²

For this analysis, CRL used the most conservative estimate of a 0.9 percent home value decline per foreclosure. We also utilize our estimates of projected foreclosures from our “Losing Ground” study that, as described on page 4, also are quite conservative compared to subsequent estimates offered by independent economists and investment banks. Further, our findings understate the total foreclosure “spillover” impact because we only include counties located in Metropolitan Statistical Areas (MSAs). A typical MSA comprises a core urban area with a population of 50,000 or more, together with adjacent communities that are economically or socially linked to that core area. Approximately 76 percent of the U.S. population lives in an MSA.³

KEY FINDINGS/ METHODOLOGY / CONCLUSION

Key Findings

We project that, nationally, foreclosures on subprime home loans originated in 2005 and 2006 will have the following impact on the neighborhoods and communities in which they occur:

• 44.5 million neighboring homes will experience devaluation because of subprime foreclosures that take place nearby.
• The total decline in house values and tax base from nearby foreclosures will be $223 billion.
• Homeowners living near foreclosed properties will see their property values decrease $5,000 on average.

These national results are the aggregation of CRL estimates of the foreclosure spillover impact for 56,777 census tracts or similar geographies.5 In each geography assessed, the cost to neighbors is affected by three factors: the number of projected subprime foreclosures, the density of local housing units, and the current value of those homes. (See “Methodology” on page 4 for further details on our analysis.) Our calculations of the lost wealth through reduced property values by neighbors is also a loss of tax base to the larger community. Thus, we use the terms reduction in property values and loss of tax base
interchangeably in this report.

As shown in Chart 1 below, 24 states and 42 counties will experience declines of over $1 billion each in local house prices and tax bases. Appendix 1 outlines CRL estimates of the spillover impact for every state and for all counties located in Metropolitan Statistical Areas.

It is beyond the scope of this research to analyze the spillover impact of subprime foreclosures on African-American and Latino homeowners in particular, but we note that communities of color will be especially harmed, since these communities receive a disproportionate share of subprime home loans.

Methodology

Estimating the Number of Homes Lost to Foreclosure

Subprime loans are not evenly distributed across neighborhoods. Rather, the distribution of subprime loans is highly correlated with such neighborhood characteristics as minority concentration and income. The geographic distribution of subprime home loans is available from annual Home Mortgage Disclosure Act (HMDA) data.⁶ For the majority of subprime home loans originated in the U.S., HMDA provides information on the census tract in which the property is located.⁷ For each census tract within a metropolitan statistical area or metropolitan division, we identify the number of subprime loans originated during 2005 and 2006.⁸ The number of subprime loan originations is then multiplied by the predicted cumulative foreclosure rate for the MSA in which the census tract is located to yield the number of expected subprime foreclosures associated with the census tract.⁹

Calculating the “Spillover” Effect

To assess the impact of foreclosed subprime loans on neighboring homes, we obtained data on the local housing unit densities and median house prices for each census tract.¹⁵ Assuming that the predicted foreclosures within each census tract are evenly distributed throughout the tract, we calculated the number of houses expected to be within an eighth of mile of each foreclosure. Immergluck and Smith (2006)¹⁶ found that foreclosures of home loans have a significant impact on nearby property values. Their “most conservative estimates indicate that each conventional foreclosure within an eighth of a mile of a single-family home results in a decline of 0.9 percent in value.” Therefore, we estimate that each foreclosed property will cause the value of these neighboring homes to decline by 0.9 percent.¹⁷ We then aggregate this loss of equity within MSAs to the county, state and the US levels.¹⁸ We estimate that that this lost home value translates into a decrease in the tax base in these counties

Conclusion

By any measure, the epidemic of home losses is severe, and will not only harm the families who lose their homes, but also nearby homeowners who suffer drops in their property values and communities who suffer the impact of lower tax revenues. Further, while the rate of subprime foreclosures is alarming today, the worst is still ahead. With as many as two million foreclosures predicted to occur in the next two to three years, it is imperative that Congress take action to assist homeowners struggling today and enact common-sense regulations to ensure this disaster does not happen again.

REFERENCES

¹ Ellen Schloemer, Wei Li, Keith Ernst, and Kathleen Keest, Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners, Center for Responsible Lending at 16 (December 2006), available at http://www.responsiblelending.org.

² Dan Immergluck and Geoff Smith, The External Costs of Foreclosure: The Impact of Single-Family Mortgage Foreclosures on Property Values, p. 57, 69, 72, 75Housing Policy Debate (17:1) Fannie Mae Foundation (2006) at http://www.fanniemaefoundation.org/programs/hpd/pdf/hpd_1701_immergluck.pdf.

³ Metropolitan statistical areasare geographic entities defined by the U.S. Office of Management and Budget for use by Federal statistical agencies in collecting, tabulating, and publishing Federal statistics. For more details, see http://www.census.gov/population/www/estimates/metroarea.html

⁴ In CRL's “Losing Ground” paper, for loans originated during 2005 and 2006, we projected 1.1 million foreclosures in the US. In the current study, our foreclosure estimates limited to first lien, owner-occupied subprime loans reported in 2005 and 2006 HMDA as “higher-cost” loans, secured by a property located in a MSA. The resulting number of foreclosures in this slightly smaller geography is estimated at 923,034.

⁵ Specifically, Block Numbering Areas (BNAs), which are geographic entities similar to census tracts and delineated in counties (or the statistical equivalents of counties) without census tracts.

⁶ For the first time in 2004, lenders were required to report the spread between the APR of designated loans and the yield on a U.S. Treasury security of comparable maturity. Specifically, lenders submitted this information on first lien loans if the spread was at or above three percentage points. In this study, we refer to loans with APRs high enough to require the disclosure of this spread as subprime loans.

⁷ According to Census Bureau, "Census tracts are small, relatively permanent geographic entities within counties... Generally, census tracts have between 2,500 and 8,000 residents and boundaries that follow visible features." Since, "census tracts are to be as homogeneous as possible with respect to population characteristics, economic status, and living conditions", they are the observation units of our study.

⁸ All figures in this analysis cover only originated conventional home loans to owner-occupants, in a Metropolitan Statistical Area or Metropolitan Division, secured by a first-lien on a 1- to 4-unit home, as disclosed under HMDA.

⁹ Subprime foreclosure rates vary across geographical locations. In addition to the difference on risky loan terms, foreclosures are more likely in housing markets with lower house price growth. This geographical variation on foreclosure rates is incorporated into our study at MSA level. See Appendix 5 of Losing Ground (note 1), p. 48. CRL projected lifetime foreclosure rates for 378 MSAs. For the remaining 9 MSAs in the HMDA data, we assume the same foreclosure rate as the US average foreclosure rate (19.4%).

¹⁰ See Schloemer et al, note 1.

¹¹ Christopher L. Cagan, Mortgage Payment Reset: The Issue and the Impact, First American CoreLogic (March 19, 2007) and quoted in Subprime Borrowers to Lose Homes at Record Pace as Rates Rise, Bloomberg.com (September 19, 2007), available at http://www.facorelogic.com/uploadedFiles/Newsroom/Studies_and_Briefs/Studies/20070048MortgagePaymentResetStudy_FINAL.pdf and http://www.bloomberg.com/apps/news?pid=email_en&refer=finance&sid=akOEPec30TR4, respectively.

¹² Mortgage Finance Industry Overview, Lehman Brothers Equity Research (December 22, 2006).

¹³ Mark Zandi, Statement before the House Judiciary Committee United States House of Representatives (October 30, 2007) available at http://judiciary.house.gov/OversightTestimony.aspx?ID=1188

¹⁴ Market Tabs, Credit Suisse Fixed Income Research (October 26, 2007).

¹⁵ Data collected from the Summary File 3 database of 2000 Census.

¹⁶ See Immergluck et al, note 2.

¹⁷ For a census tract, let A be the area size in square miles, B be the number of foreclosed subprime loans, C be the number of housing units, and D be the median house price. Let G=64A/ƒÎ. Then the number of neighboring homes experiencing devaluation is given by

H= C if B is greater than or equal to G

CxB/G, if B is less than G (1)

The dollar amount of decrease in house value/tax base from foreclosure effect is given by

I = 0.009 xCxDxB/G (2).

¹⁸ In 2005 HMDA data, there are total of 387 MSAs. For these MSAs, there are total of 1,158 counties and 53,293 census tracts. In 2006 HMDA data, there are total of 387 MSAs. For these MSAs, there are total of 1,158 counties and 53,245 census tracts. Combining both years yields 56,777 census tracts.