These hearings pointed out that subprime borrowers are at the greatest risk of foreclosure due to exotic lending. These loans have been targeted at the less educated, lower-income folks, usually minorities. Whereas only 10% of prime loans have a prepayment penalty, over 80% of subprime loans have a prepayment penalty.

The subprime borrowers have to time their refinancing just right: if they do it one month before their 2 year teaser period expires, they incur steep prepayment penalties (often 6 months interest). If they refinance after their 2 year teaser period ends, they get hit with a payment shock, where the new payment can actually exceed their gross income.

Furthermore, as I explained above, subprime borrowers are qualified for principal and interest at a 55% debt ratio on the intial teaser rate! Now add taxes and insurance, and in year 3 add the higher payments due to the end of the teaser rate + add the higher interest rate that is in effect now, and you’ve got a person in foreclosure. One of the regulators said a loan payment like that can TRIPLE.