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CHAPEL HILL, N.C. – With the topic of foreclosure becoming central in the discussion about the expansion of the subprime lending market and increasing concerns about the way predatory mortgages erode housing equity, a newly released report by the University of North Carolina at Chapel Hill’s Center for Community Capitalism finds that predatory lending terms – prepayment penalties and balloon payments – increase the risk of mortgage foreclosure in subprime home loans, even after controlling for the borrower’s credit score, loan terms, and varying economic conditions. According to the Center for Community Capitalism, subprime loan originations increased from $35 billion to $332 billion between 1994-2003. In the fourth quarter 2003, 2.13% of all subprime loans in the U.S. entered into foreclosure – that was more than 10 times higher than the rate for all prime loans. In the same period, more than one out of every 20 subprime borrowers was in the foreclosure pipeline and at risk of losing their home, compared to just one out of every 100 prime borrowers. Refinance loans with prepayment penalties and those with balloon payments are more likely to experience a foreclosure than loans without these features – about 20% and 50%, respectively. In addition, the report found that the use of prepayment penalties and balloon payment requirements in 1999 refinance originations increased foreclosure-related losses by about $465 and $127 million nationally, respectively. “Prepayment penalties are distinct characteristics of subprime loans.Because they impose significant costs to the borrower for exercising the call option, prepayment penalties extend the average life of a typical mortgage, thereby increasing default risk.If prepayment penalties slow down prepayment speed, they keep the default option alive longer,” the report states. The report further found that not only are subprime foreclosures disproportionately high, but they also occur earlier in the loan term than prime loan foreclosures. This suggests, say the study’s authors, that “the loans were not affordable for the mortgagors even at the time of the origination.” Dr. Michael Stegman, director of UNC’s Center for Community Capitalism said the study demonstrates that subprime prepayment penalties and balloon payments place Americans at substantially greater risk of losing their homes.

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