Interest Rates in the Sub-Prime Mortgage Market

Abstract

Sub-prime lending has grown rapidly in the mortgage market. According to Inside Mortgage Finance (IMF), sub-prime mortgage lending increased from approximately 65 billion dollars in 1995 to over 213 billion dollars in 2002. This growth accelerated in 2003 as the market grew by another 119 billion dollars to reach 332 billion dollars (IMF 2004).1 By providing access to credit to those otherwise denied a mortgage in the traditional prime market, the sub-prime market can enhance welfare by completing the mortgage market (Chinloy and MacDonald 2005). Sub-prime credit gives more households the opportunity to become homeowners, as well as providing better access to equity held in the home through refinances and second mortgages. Despite the growth in sub-prime lending, little is known about the pricing of the sub-prime credit. This chapter helps fill this gap by examining the determinants of interest rates charged to sub-prime mortgage borrowers.