By Kyle Olson
Subprime loans are and always were a calculated risk for lenders. Of course some of these mortgage loans would end badly, but the higher percentage of them were supposed to be fine and that would make up for the ones that ended up in foreclosure. The subprime gamble paid off well for brokers for a few years, but no one seemed to consider that the massive amount of quick and easy subprime loans were setting the housing market up for disaster.
According to an article by Sherry Karabin on Law.com, the litigation that has followed the subprime mortgage crisis was somewhat expected, except that it is far worse than anyone could have imagined. Karabin reports that hundreds of subprime-related lawsuits have already been filed and by the end of the year there will be many more.
Chicago-based Navigant Consulting Inc. has published a detailed study of current subprime litigation. The firm reports that during the first quarter of 2008 alone, 448 subprime-related lawsuits were filed in federal court. Approximately 86 percent of these lawsuits are still active. The FBI is looking into many more subprime issues within the market.
Subprime lending is not a new concept. Lenders and brokers arranged mortgage loans with less stringent underwriting and appraisal standards for people with less-than-perfect credit for years before the housing market collapse and foreclosure epidemic. However, around 2001, the number of subprime mortgage loans began to rise, and from 2005 to 2007, an enormous amount of people began to use their homes as personal ATM machines and used subprime loans to refinance and cash-out their home equity.
At the time, it didn't seem to be a problem because home values were skyrocketing and many homeowners felt as though there was no end in sight. When the housing market suddenly collapsed, these homeowners realized they were not sitting on a pot of gold and their homes were not worth nearly what they were in previous years.
This would not have been so much of a problem if homeowners could have continued making their existing mortgage payments on subprime loans, but this was not the case. A tremendous number of the subprime loans made during the housing market boom were adjustable-rate mortgages. This is a type of loan offered with a low teaser interest rate for the first two years, then the loan resets at a much higher interest rate.
Plenty of subprime brokers made deals with homeowners during the lending heyday, promising them that if they took the adjustable-rate mortgage loans that they would easily be able to refinance just before the interest rate was due to reset.
If the housing and lending markets had continued as they were, this might have been the case, however, before these subprime mortgage loans reset, the housing market imploded and the credit market tightened. Therefore millions of homeowners found that they were stuck in adjustable-rate mortgages and could not possibly afford to make the mortgage payments after the interest rates reset. In the wake, many filed for bankruptcy.
Some homeowners were already struggling with consumer debt and job loss and even had problems making mortgage payments at the lower teaser rates, so after the interest rates reset, a nationwide foreclosure epidemic which was in the works for years began.
Now the subprime lawsuits have started. In late 2007 they began and have built up to the point that currently averages of two subprime-related lawsuits are filed in federal court every day, including weekends. According to the data collected by Navigant Consulting Inc., 45 percent of the subprime-related lawsuits filed so far have been borrower class action lawsuits. These plaintiffs are a drop in the bucket of those affected by the mortgage foreclosure epidemic and won't have much of an effect on sending a message to lenders because they will not be eligible for large awards for damages.
On the other hand, 105 of the subprime-related lawsuits are securities cases, which have the potential to damage lenders to a much greater degree. About half of the securities lawsuits are securities fraud class action cases, filed to make an impact and send a message although they will be very complex, lengthy and expensive cases to litigate.
Although there are now very few subprime loans issued these days, the rush of subprime-related lawsuits may be just beginning. There may be far more plaintiffs yet to step forward after they speak with lawyers about how to assess their damages and decide how to make a claim that will make an impact. The remainder of 2008 will be interesting on this front.