Understanding Subprime Mortgage Default

Abstract

The explosive growth of subprime mortgage originations in the early 2000s coincided with the initial formation, and subsequent collapse, of the residential housing bubble. Given their relatively poor credit histories and lack of loan documentation, borrowers in the subprime market were at a greater risk of default than borrowers in the prime market. Yet, despite all the warning signs, these borrowers were able to obtain subprime mortgages. Why did mortgage originators provide subprime loans to borrowers who could not afford them? Why did these borrowers ultimately default on their loans? How can we best prevent another housing market collapse? Academics, industry practitioners, and policymakers alike must address these questions, and several others, so that we can better understand why subprime default rates hit unprecedented levels not observed since the Great Depression. In this paper, we review the extant literature on the underlying determinants of the subprime mortgage crisis with an emphasis on (1) predatory lending and anti-predatory lending laws, (2) declines in house price appreciation rates, (3) securitization, (4) deteriorating underwriting standards and inaccurate credit risk models, and (5) alternative mortgage products.