A subprime loan is a loan given to people with low credit scores. Those loans are either:
1) At a much higher interest rate, or 2) With closing costs and/or points through the roof.
Either way it is highway robbery!
I've debated before about the close call of buying vs renting and even steered many people toward renting by dispelling the myths of "making your landlord rich" and the "tax savings" etc. See Don't Buy Ask Why blog.
In today's market, even after the declining prices, renting is still cheaper, even after all the tax "breaks."
(and those of you who want to use technicalities and say "what if I put 50% down," you can go to the back of the room. Rent Vs Buy numbers should be done as if you were doing 100% financing, or else they aren't accurate.)
So, if the rent vs buy (see RvB NYT Article I was in) equation is a close call for somebody with a good credit score, let's look at the equation with somebody with a POOR credit score putting NO money down and paying up the wazoo in high rates or closing costs.
Let's first back up and talk about how loan officers make their money. They either make their money 1) Up front with "points" or 2) On the back end with a higher rate. (or a combo of the above)
(Sidenote: With subprime there is more tom foolery, up front points and padded profits since the lender is trapped and feels they have fewer options. Also the lender charges more for the added hassle factor.)
They make the same money either way, so which route they show you is called MARKETING! So with Subprime, lenders love to pile on the points (closing costs) and say "the seller is paying for it."
Um, hello, McFly! DON'T BE FOOLED! YOU ARE PAYING IT!
Example: $300,000 with $15,000 "seller subsidy" or $285,000 with $0.00 subsidy
Which do you think the seller will prefer? They are the SAME. So lets stop pretending that closing costs are free found money. It is your money.
So the subprime lender wants to mask the TRUE rate of your loan, which is something like 1 0% and they "buy it down" to a more sexy 6% loan (sometimes for only 2 years, then it adjusts higher or they scam you into another refi). Why? Because you "can't afford 10% a month" And their solution is for you to take the $15,000 (that you also can't afford) and fudge the numbers to LOOK like you can afford it! That is like moving money from one pocket to another pocket.
And then they change hats in a couple of years and give you a "no points" or "no cost" refinance. As per the #2 "how a lender makes money" above, they make it with a higher interest rate. Because there is no seller to "pay closing costs" they use marketing again and they build the fee back into the loan with a higher interest rate. Regardless they are making money off you yet again!
Back to your subprime loan on your current purchase. Another way to look at it is if you opted for a no points 10% loan, you kept that $15,000 in the bank and you used $500 per month to subsidize (apply toward your ultra high loan) your monthly loan. That $15,000 would last you 30 months!
So when running the numbers, to get a TRUE idea what your REAL costs are, you need to ask: "What is your rate with NO POINTS."
The numbers will suck, but that is reality (or is it realty?).
Recently I ran the numbers and found that for a subprime loan, after all expenses, condo fees, taxes etc were included, the total monthly amount was:
Subprime loan for a 1bdr total = $2,500 a month
I asked the person what it would cost to rent that same place.
Answer: Rental amount= $1200
Renting will save this person $1,300 x 12 or $15,600 EACH Year!
That is over $45,000 TAX FREE in 3 years if they rented! Sidenote: You have heard about being able to write your interest off on your taxes right? Keep in mind that this tax break is for the rich! Yes, if you are not rich, you get substantially LESS tax breaks. If you are in the 15-20% tax bracket, you get to "write off" your interest, but you get HALF the credit that somebody in the 30-40% tax bracket gets. And if your loan is large enough, it can LOWER you into an even lower bracket. Sounds good, but this is BAD since it lowers the amount you get to write off.
So what are the possible reasons one might come up with to justifying hurrying into a place now with a poor credit score?
1) Some might say "But rates may going up." To that you have to look at your loan. Many subprime loans are ARMS and they adjust after a couple of years. If rates go up, and you have an ARM, you will just REFI into the higher new rates. If your subprime loan fixes your rate for 30 years, you will have to do the math. (avoid loans with teaser rates that start lower for 2 years, if you can't afford it now, you can't afford it later when it goes up)! I bet if you take that $45,000 in savings over three years, and you fix your credit and buy a place in 3 years, even if rates go up, you will still be much better off.
2) "What if home prices are going up and I need to get a house fast!" More reason NOT to buy. If the market is going up, all is dandy, but you have to run the numbers if the market goes down! You will be stuck in your house for years until the market rebounds. And no, you can't just rent it, since rent won't cover the mortgage.
Sidenote: Watch out, subprime loans also oftentimes have large prepayment penalties. You can't just refi or sell without paying the bank ANOTHER $5,000 to $20,000! So you are locked in!
Remember TEASER= TAZER Do not get a loan that automatically goes up later. Those are called Teaser rates. Teaser rates will HURT when they go up 20-100%. If you can't afford it now, you won't be able to afford it later!
Fix your credit scores first, and THEN consider buying. Here is where you can get started to fix your credit scores.
Bottom line is the American Dream is NOT for people with low credit scores. Sorry, I know the white picket fence, or small condo gives you that warm and fuzzy, but so does heartburn.
It just doesn't make any financial sense.
And the blog doesn't end here. I promise there will be heated debate under the "comments" section. Please add your comments. You might learn MORE from the comment than from this blog.
- Written by Frank Borges LL0SA- Broker/Owner FranklyRealty.com 703-827-4OO6 Please report all typos, I don't like looking stupid. If you like this post, sign up for new blogs daily, use the form on the right of the page.
This blog, in video form:
Nice bald head!
24 Comments on Avoid Subprime Loans! Just Don't Buy!
JUN
07
2007
Lots of food for thought here. Hope we see some lenders weigh in on your opinions. I think it's also important for those subprime borrowers to really work on cleaning up their credit so if they've already bought they can dig themselves out from under.
Hey Frank, I agree with you on the american dream, but I don't agree the american dream is ONLY for those who have a very good credit or deserve it. Everyone have the rights to dream and fix their mistakes in life. About the blog, I am not the author and I am just updating the news. If is good or not that is not my decision...about deserving or not, this is GOD business not ours, people know what is better for them. Thanks and have a wonderful day!
Problem is, buyers oftentimes do NOT know what is better for them, because they get tricked into crazy loans by subprime lenders, or they don't fully understand what is going on. That is why so many are going into bankruptcy!
They can have the American Dream, AFTER they fix their credit. Paying $3,000 for a place you can rent for $1200 is insane.
We get the right to decide for them, when time after time we get people that come to us and say "HELP, I'm SCREWED" and their previous lender didn't quite explain the pitfalls of subprime loans. One guy is looking to sell his house. But then I had to tell him he had a $15,000 prepayment penalty.
As for low closing costs, that is what I said in my blog. You either have low closing costs and a high rate, or you have high closing costs and a low rate. If you have both, a low rate and no closing cost then you aren't subprime.
Some really great advice as usual Frank ~ about waiting until credit is good and saving for a down! That will get you the best rates and deals!
We are watching the rental market prices blow up here so I don't know how "affordable" it is to rent after the tax breaks tho. There used to be a big disparity but the gap is really closing up to the point where it is almost cheaper to buy in this buyer's market depending on what macro market you are renting in and you can buy in!
Another question: At what point does a Realtor have an obligation to not allow financial suicide? If we see somebody "buying at all costs" and they have horrible credit, and we don't see it possible for them to be able to pay their mortgage, do we stop them? Do we send them elsewhere?
A bartender has to cut off a drunk who has had too much to drink, does a Realtor have to cut off somebody about to do harm to themselves? Or is it a case of "who are you to stop somebody from the American Dream."
Personally I couldn't help somebody buy a place in such extreme situations, if they didn't give me a good enough of an explanation.
Yes Missy your right I have had some buyers give me the I will do ANYTHING to get that house. Ususally it's a 6+ month waiting period to clean up that awful credit. But they want it now 10%, whatever, they say. I can't even find banks that will loan in Michigan anymore due to the high forclosures.
However it still is cheaper to buy than rent here in Mid-Michigan.
I've been thinking more about your comment that it is cheaper to buy than to rent in Vegas. Really? I would love to see some real numbers of a typical house bought with 100% and the equivalent rental. I'd be shocked if it really cost less to rent.
to be quite "frank" about it, I would do everything in my power to help someone buy a home, but if I honestly see that they are putting the knife to their own throat, I won't stanby and watch for 3%.
I'll be the first to tell a person to clean their credit up FIRST. People have a tendency to actually appreciate the fact that you helped them initiate something they've known they needed to do in the first place. Showing them what they would get with their current crappy credit, and showing what they could get with BETTER credit, makes sense to the rational responsible potential buyer.
I have a client I've been working with for the past year now. When I met him he was a low 400; as of April he was in the 600...I asked if he was ready to buy a home and he said NO! He wants to push for 700-something so he can get what he really wants at a better rate. Now, mind you, he wasn't thinking that way when he came through my door! He had the spoiled, snotty-nosed, wide-eyed child mindset of "I want it NOOOW!!!" But I sat him down, reasoned with him, and now he sees the benefit of taking my advice.
Helping someone improve their credit puts them in better postition for many other things BESIDES a home, and the customer will have YOU to thank for it!
To me, that's truly HELPING PEOPLE!!
I have to agree that it is not always the best deal to buy if you are in a Subprime situation. The Buyer has to use common sense. If it will cost more to buy (because of their rate) then to rent then they they should rent until they can get a better rate. I try to convince my customers to go with a fixed rate subprime or not. I would feel better knowing that their payment is a little higher and it is not going to change then to see their credit not improve and the rates continue to rise. We do not have a crystal ball that says what the rates are going to be in the future. If I give them a fixed rate I am sure. If they fix their credit they can refinance later to a better rate.
Your comments about subprime are a little exaggerated. Every borrower pays fees or a higher rate so that the bank, lender or broker gets paid. No one, and I mean no one including the banks work for free. When banks offer a rate with 1 point, that is actually the par rate and the 1 point goes to the bank as there fee.
I will agree that many brokers with hard core sales skills have overcharged many a clients on the subprime side, but this cannot be said for all mortgage brokers or all subprime customers.
To be fair, there are plenty of realtors that will push a client to a house just over the upper end of their given price range and then push the loan officer they work with to just make it happen. If you are going to hammer away at loan officers, then let's give an equal scolding to those greedy realtors who just have a commission in mind.
Brian, you missed the point, or you didn't read the blog. I am NOT blaming the banks for charging more. I understand that they have to do this to cover the risk. I'm instead blaming the BUYERS for buying before fixing up their credit.
Bottom line is many buyers wanted these loans. They thought that real estate prices would continue to climb through the roof and that it would work itself out. I guarantee you that many buyers were told, don't worry about we will refinance you out of this loan before it adjusts.
Credit is not as easy to fix as believed. A little responsiblity goes a long way over time.
I can certainly appreciate how you might arrive at your conclusion given some of the exotic financing schemes we've all seen. However, I don't believe you've taken into account several things; some of which can not be measured.
Let's assume your example of a $285,000 loan at 10% over 30 years for a $2,500 PI payment versus the same unit which would rent at $1,200 for three years. Let's also factor in a modest annual appreciation of 3.5% (given the last 15 year national average appreciation of 5.65%) and we'll assume a tax bracket of 25% (which should always be before adjustments). We'd look something like this:
$285,000 @10% = $2,501 PI $2,881 PITI (based on CA tax & ins rates)
$2501 - $625 (mo. tax break) = $1,875 x 36 months = $67,500
$1,200 rent x 36 months = $43,200
Savings from Renting= $24,300
$285,000 at 3.5% appreciation y-o-y = $315,984 or $30,984
When we factor our home appreciation against our savings from renting we increase our net worth by $6,684. What can not be measured is the emotional and physical value one places on home ownership; for some quite invaluable.
Naturally these are raw or rough numbers, just as yours are and there are variable factors that change things in either direction, good or bad. My point is, that were we to stay in the home over a full market cycle of say 5 to 6 years in combination with our potential to having been in the process of repairing our credit and then refinance into a more attractive loan, the value of home ownership versus renting would be measurably more, despite the higher rate we began with due to the value of appreciation.
It isn't always a cut and dry situation. It depends upon the area of purchase, the diligence of the buyer, the type of credit issues being dealt with etc. So while renting may be "cheaper" it may not always prove to be the wisest "investment" in the long run, given the individual situation.
Just some food for thought and acknowledgment that many of yours were valid.
Helene McElmurray, CMPS
We will have to agree to disagree. Yeah sure the warm and fuzzy is all fine and dandy, but so is a trip Hawaii! It might feel good, but it will put you deeper in debt and further from any goal of getting your credit score down.
Rather then paying a ton of closing costs and a 30-50% premium for a couple of years until the credit is repaired, and THEN REFINANCING (that means another round of fees), just use those extra funds (savings while renting) to fix your credit faster!
In other words, getting a super expensive loan is like digging a deeper ditch. You want to improve your credit to refinance... but you can't since your mortgage is so huge.
So just rent, take that savings and it will result in improving your credit in HALF the time.
Don't get trapped into the American Dream via a shortcut (super high rates that get you in now), as it will turn into the American Nightmare.
Disclaimer: ActiveRain Corp. does not necessarily endorse the real estate agents, loan officers and brokers listed on this site. These real estate profiles, blogs and blog entries are provided here as a courtesy to our visitors to help them make an informed decision when buying or selling a house. ActiveRain Corp. takes no responsibility for the content in these profiles, that are written by the members of this community.
;)
;)
