OCTOBER 2007 :: COVER STORY : NATIONAL

There Goes the Neighborhood
Will Easy Credit Eliminate More Homeowners Than It Creates?

BY MARK WHITEHOUSE
The Wall Street Journal

For decades, the 5100 block of West Outer Drive in Detroit has been a model of middle-class homeownership, part of an urban enclave of well-kept houses and manicured lawns. But on a recent spring day, locals saw something disturbing: dandelions growing wild on several properties.

"When I see dandelions, I worry," says Sylvia Hollifield, who has lived on the block for more than 20 years.

Ms. Hollifield's concern is well-founded. Her neighbors are losing interest in their lawns because they're losing their homes-a result of the recent boom in "subprime" lending, loans aimed at people with poor or patchy credit.

Over the past several years, seven of the 26 households on the block have taken out subprime loans. Some used the money to buy their houses. But most already owned homes and used the loans to pay off credit cards and do renovations. Three now face eviction because they couldn't meet rising monthly payments. Two more are showing signs of distress.

"This has stripped us of our whole pride," says April Williams, who recently was facing eviction from the two-story Colonial where she and her husband lived for 11 years. "There's going to be no people left in Detroit if they keep doing this to them."

PRECARIOUS POSITIONS

A similar drama is playing out in middle- to lower-income areas across the country. In addition to putting families into homes, subprime loans and the mortgage brokers who peddle them are helping to take families out of homes in which they've lived for years. This raises questions about how the extension of easy credit to large swaths of the U.S. population will ultimately affect people and the broader economy.

The subprime market has channeled a surprising amount of money into some of America's poorer and more-troubled local economies. In 2006 alone, more than a billion dollars in subprime-loan funds were injected into 22 ZIP Codes in Detroit, where home values were falling, unemployment was rising and the foreclosure rate was already the nation's highest. Fourteen ZIP Codes in Memphis, Tenn., attracted an estimated $460 million. Seventeen ZIP Codes in Newark, N.J., pulled in about $1.5 billion. In all of those ZIP Codes, more than half of all home loans made were subprime.

The figures show the extent to which the new world of mortgage finance has made the dream of homeownership accessible to people in once-underserved communities. By some estimates, subprime lending has accounted for as much as half of the past decade's rise in the U.S. homeownership rate to 69% from 65%. But the flood of cash has also encouraged people to get into financially precarious positions. In doing so, it may have worsened some of the nation's biggest economic problems.

If events unfold as some predict, subprime lending could end up eliminating more homeowners than it created. One study by the Center for Responsible Lending, a nonprofit that focuses on abusive lending practices, forecasts that the subprime boom will result in a total of 2.4 million foreclosures nationwide, most of them on homes people owned before taking out the loans. That outweighs even the most optimistic estimates of the number of homeowners created, which don't exceed two million.

To understand how the legacy of subprime lending looks on the ground, take a ride around the West Outer Drive area with Carlton McBurrows, a community organizer who grew up in the neighborhood. On one recent day, he counted four empty houses with big red refuse bins outside-a sign that banks, having repossessed the homes, were tossing out all the belongings left behind. "This is a phenomenon that I've never seen before," he says. "I think this is just the beginning."

A credit glut in the West Outer Drive area would have once been inconceivable. Many blacks moving into the neighborhood had to either depend on federal mortgage programs or buy their homes in cash. That's because banks actively avoided lending to them, a practice known as "redlining." Decades of government efforts to combat redlining had little effect.

But beginning in the mid-1990s, the evolution of subprime lending into a global market helped moderate the risks for lenders. Suddenly, mortgage lenders saw places like West Outer Drive as attractive targets for new business, because so many families either owned their homes outright or owed much less on their mortgages than their homes were worth. Lenders seeking to tap that equity bombarded the area with advertisements and armies of agents and brokers, often peddling loans that veiled high interest rates and fat fees behind low introductory payments. The more contracts they could sign, the more money they stood to make.

The boom in subprime lending paved the way to homeownership for many people: Over the past three years, three people on the 5100 block have used subprime loans to buy homes. In at least two of those cases, though, the experience has not gone well. Raymond Dixon, a 36-year-old with his own business installing security systems, borrowed $180,000 in 2004 to buy a first home for himself, his wife and six children, across the street from Ms. Hollifield at 5151 West Outer Drive. After all the papers had been signed, he says, he realized that he had paid more than $20,000 to the broker and other go-betweens. "They took us for a ride," he says.

Bishop Charles Ellis, a pastor at the Greater Grace Temple in Detroit, says he has heard many such complaints from people in the area. Still, he believes many bear responsibility for their situation. "If you have a contract in front of you, you have to read that contract," he says.

Mr. Dixon defaulted on the loan after the monthly payment jumped to more than $1,500 from $1,142, and by the end of the summer was facing eviction.

Up at the north end of the block, Jennifer Moore and her husband, John, bought a two-story beige-brick house in December 2004. She says her husband had excellent credit, but in the rush to buy his "dream house" he agreed to take out two subprime loans, one for $164,000 and the other for $41,000-a "piggyback" arrangement that allowed him to avoid a down payment. Ms. Moore said the real-estate agent told them they could refinance into a fixed-rate loan within two years, after which the payments on the larger loan were scheduled to reset.

Mr. Moore's death in 2006 scuttled the refinancing plans. Now Ms. Moore, a 56-year-old clerical worker for Wayne County, has fallen behind on the monthly mortgage payments, which she says rose earlier this year to $2,200 from about $1,450. After more than 30 years as a homeowner, she now expects to lose the house. "I'll get an apartment," she says. "I'm not going to buy another place."

'I KNEW BETTER'

For many who already owned homes, offers of easy credit came at a time when an economic downturn had left them in need of money to maintain middle-class lifestyles.

April Williams was feeling the pain of the downturn back in 2002, when she saw an ad from a subprime lender offering cash to solve her financial problems. At the time, production slowdowns at Ford Motor were squeezing her husband's income from an assembly-line job, and they'd heard rumors that more cutbacks were coming. Still, after a loan officer paid a visit, they became convinced they could afford new appliances, custom tile, a new bay window, and central air-conditioning-and a $195,500 loan to pay off their old mortgage and pay for the improvements. The loan carried an interest rate of 9.75% for the first two years, then a "margin" of 9.125 percentage points over a variable interest-rate index called the six-month Libor. The index has been at 5.4% recently, which would put Ms. Williams's interest rate at more than 14.5%. (The average subprime loan charges a margin of about 6.5 percentage points over the six-month Libor.) "I knew better than to be stupid like that," she says. "But they caught me at a time when I was down."

Ms. Williams finds herself in a predicament now common among homeowners in Detroit: They've tried to sell, but can't find buyers willing to pay what they owe on their loans. After two years on the market, Ms. Williams says her house has attracted a high bid of $140,000, nowhere near the $211,000 debt she must settle to avoid eviction. That leaves her with little option but to abandon the house.

Kevin Lightsey, a local real-estate agent, says he doubts such foreclosed homes are likely to find buyers. "Nobody's going to want to buy into a neighborhood with 20% foreclosures," he says. "You end up with no neighborhood."