Time to Give Up the House?

A new study finds that, in a shift from the past, subprime borrowers are paying their credit cards before their mortgages

by Peter Coy

For generations, homebuyers have had one simple rule drilled into their heads: Whatever happens, keep paying the mortgage. If you don't, you risk losing your house and all the equity you've built up in it.

But for many subprime borrowers, that doesn't seem to be the rule of thumb anymore. They are now more likely to be late on their mortgage than on their credit card, according to a new study from Experian Group, the Ireland-based company that maintains a huge database of consumer credit histories.

Card Priority

The significance? One explanation could be that many recent subprime homebuyers simply aren't that worried about losing their homes because they don't have much to lose. Most put down small or zero down payments. If prices have fallen since they bought, they may actually owe more than the house is worth, making it an easy choice to walk away.

At the same time, keeping access to their credit cards has become more important than ever, says Stan Oliai, vice-president of decision sciences for Experian Decision Analytics. "People are using credit cards for everyday items like gasoline and groceries, and to tide themselves over from paycheck to paycheck," says Oliai.

Experian's study, released June 20, says that the share of subprime borrowers who were 30 days or more late on their mortgages went up from about 32% at the beginning of 2003 to around 36% at the end of 2006—a sign of increasing financial distress.

Yet those same subprime borrowers actually caught up on their credit cards over the same period. The share who were 30 days or more late on their cards fell from 32% to around 24% between early 2003 and late 2006. (That's for borrowers with Experian credit scores under 620; people with scores over 680 are considered prime borrowers.)

Little "Skin in the Game"

Fears of widespread fallout from subprime borrowing have spread in recent days. Early this year, it appeared that the troubles would be contained to relatively small lenders, such as NovaStar Financial (NFI), Accredited Home Lenders (LEND), and New Century Financial (NEW) (see BusinessWeek.com, 2/22/07, "A Painful Hiss from the Subprime Balloon"). But in the past few days, Bear Stearns (BSC) has run into trouble with two hedge funds it manages that have taken on subprime exposure. That prompted a broad market selloff on June 20, with the Dow Jones industrial average down 146 points (see BusinessWeek.com, 6/20/07, "Stocks Swoon on Subprime Fears").

According to Experian's research, prime borrowers have exhibited more conventional behavior than subprime ones, perhaps because they have more to lose from a home foreclosure and aren't quite as reliant on credit cards to get them through the month. Experian's study shows that they remain less likely to be late on their mortgages than on their credit cards.

Many subprime mortgage borrowers "don't have much skin in the game," says Douglas Duncan, chief economist of the Mortgage Bankers Assn. Subprime loans that originated in 2004 and 2005—which account for a big share of those now entering delinquency—involved extremely small down payments, Duncan says. "Some people said, 'Let's roll the dice and see if we can get a house. And if it doesn't stick, we've still got to have the credit card to keep going and we've got to have the car to get to work.'"

Other Explanations

• Subprime borrowers may be keeping up on their credit card debt because they're aware that the new federal bankruptcy law makes it much harder to shed that debt with a declaration of bankruptcy, Oliai says.

• Subprime borrowers may realize that they have a lot more leeway to be late on mortgage payments. The very earliest that foreclosure can occur, in certain states, is four months. It typically takes six months to a year, and in some places it can take over two years, notes Duncan.

• Or maybe borrowers aren't being strategic after all. They're simply overcome by the debts they face, in particular rising payments on adjustable-rate mortgages whose teaser rates are expiring and whose underlying index is going up. "I don't know about this notion that consumers are being so calculating about this," says Allen Fishbein of the Consumer Federation of America. "This explosion of subprime loans has just overwhelmed them."

Coy is BusinessWeek's Economics Editor.