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A brief relection on the Sub-Prime Market...

By
Mortgage and Lending with Century 21 Mortgage

I've gotten numerous questions on the sub-prime market.  Is it still there?  Can someone with a 550 credit score still get a loan?

When I am asked if someone with sub-prime credit can still get a loan, my answer is YES.  The REAL question is can someone get a loan that is GOOD for them and fits their NEEDS.

With regards to whether it is good for them I reflect back on some of my recent readings on historical rates in the sub-prime market.  Just over two years ago you could get a loan under 8% and some under 7% with a 500 credit score!  Well, I'd like to say that those rates were still available, but in the sub-prime world, they just aren't.  Now, you need a minimum of 520 and the starting rate is double-digits...  typically NOT a GOOD loan for your borrower.

Two things are happening in the sub-prime world (apart from the obvious closing of doors by many in the market).  Rates are changing and guidelines are changing.  Up until recently the rate increase was tracking closely with the rest of the market.  When rates on regular (conventional, conforming, A-paper) loans went up, so did sub-prime rates.  When those same rates went down, sub-prime followed.  Now, however, rates have currently and dramatically begun to rise b/c the secondary markets and investors have lost their appetite for these type of loans.  In a nut-shell -- every so often lenders and banks sell their loans to replenish their source of money to lend to borrowers.  Well, if no one will buy them, there is no more money to lend (kind of over simplified, but you get the idea).  Well, how do you get people to buy them?  Give them a better price -- meaning raise the rates charged to the borrower so that the people with the actual money are willing to risk lending them money!  Below is a snapshot of how the mortgage market functions from loan origination to who is actually investing:

Diagram of Mortgage Market Actors

Source:  DiPasquale and Wheaton, Urban Economics and Real Estate Markets.  Prentice-Hall, 1996.

Second, the guidelines are tightening.  Basically if your credit score was X and you get get Y% Loan-To-Value, you now need to have a credit score of X+20 and you can only get Y-10% LTV.  Other guidelines relate to the type of income and asset documentation you provide.  Historically and still today, most sub-prime lenders do not require you to document the source of your assets.  However, most allowed for very high loan-to-values with a stated income. 

From an objective and analytical standpoint, it is fairly easy to see why sub-prime loans were a much higher-risk.  When developing a credit profile of a potential customer, underwriters look at the credit score, your income and your assets.  Any of these factors can help or hurt your overall profile.  In the sub-prime world, the credit score is typically bad.  So, when you combine that with no proof of income (stated income) and no need to prove assets (stated assets) you can easily see why there MAY be some issues down the road. 

The final nail in the proverbial coffin is/was that most sub-prime loans are 2/28's.  This means they are fixed for 2 years then adjustable for the remainder of the amortization period (2+28=30).  So, if you got a loan in 2005 that was attractive and affordable -- it is not that way any more.  And, if you have not improved your credit/income/asset position, well -- can anyone say foreclosure?

Please feel free to comment on the past and your feelings of the future of the sub-prime industry.

Comments (12)

New Jersey Real Estate James Boyer Morris, Essex & Union County NJ Realtor
RE/MAX Properties Unlimited, Real Estate - Morristown, NJ

The lesson that consumers need to learn is that credit score is important, pay your bills, just pay your bills on time consumer, don't over extend yourself living beyond your means.  Doing so only makes your life worse in the long run.

 

James Boyer

Realtor Associate

Keller Williams Real Estate

Summit, NJ 07901

Aug 17, 2007 02:37 AM
Joe Kupiszewski
Century 21 Mortgage - Tallahassee, FL
~James~ Simple but sage advice!!!
Aug 17, 2007 02:43 AM
» Bill Burress Nationwide Mortgage Originator
» Bill Burress Nationwide Mortgage Originator - Fort Myers, FL

James:

I think the biggest problem currently is the secondary market is non functioning.

Aug 17, 2007 03:11 AM
Aracely Barraza
Realty Executives Platinum - Palmdale, CA
i  will print this it helps understand the business more.
Aug 17, 2007 03:22 AM
Joe Kupiszewski
Century 21 Mortgage - Tallahassee, FL

~Bill~  Another good point!  Secondary market has all but closed its doors :)

~Aracely~ Glad it helps - it is pretty clear and not too technically overwhelming!

Aug 17, 2007 03:45 AM
Joe Manausa - Tallahassee, FL
Joe Manausa Real Estate - Tallahassee, FL
Tallahassee Real Estate
Great graphic and clear to understand. Thanks Joe.
Aug 18, 2007 12:07 AM
Joe Manausa - Tallahassee, FL
Joe Manausa Real Estate - Tallahassee, FL
Tallahassee Real Estate
Joe, one point I'd like to make though. When talking about double-digit interest rates, you stated "typically NOT a GOOD loan for your borrower" I disagree. If this is what is available, the borrower buys less house and uses this loan to establish a higher credit rating. He can always refi in the future once he brings his credit up. Loans like this are GOOD for some people. Too often, we think the rate is too high and we don't push hard for the buyer to scale down and repair his credit. That does not serve his needs!
Aug 18, 2007 12:10 AM
Anonymous
Anonymous

~Joe~ Thanks for the comments.  There are certainly some instances where it is not only necessary, but in the best interest of the borrower.  As the sub-prime market is shifting towards, full-doc, higher interest rates and lower LTVs I think the people who can work with that type of loan will fit into the profile you discuss more appropriately.  I have just seen too many people get into loans they should not have gotten into.  Much of this was in the refi boom and so those are a somewhat different type of customer altogether.  Thanks again for the comments.

Aug 18, 2007 02:26 AM
#8
Joe Manausa - Tallahassee, FL
Joe Manausa Real Estate - Tallahassee, FL
Tallahassee Real Estate
I agree Joe. Unfortunately, we're all seeing the fallout from those loans right now.
Aug 18, 2007 10:36 PM
Seth Callen
Farmers Insurance - Lawton, OK
Great post.  That was a simple yet understandable diagram.  Thanks.
Aug 19, 2007 02:08 AM
Kate Bourland
Marketing with Kate - Redding, CA
Onlilne Marketing Mobile Marketing

This is a wonderful, easy to understand explanation of what is happening.  The comments are very thoughtful too.

Why not, double digits as long as it doesn't have a long pre-pay penalty on it.  Now is a great time to buy a home and the market is working in reverse from a six months ago.  Higher interest rates/lower house prices. The homebuyer buys now, helps to re-establish credit and then refinances later.

Something to think about. 

Aug 19, 2007 02:13 AM
Joe Kupiszewski
Century 21 Mortgage - Tallahassee, FL

~Seth~  Thanks, I refer to that diagram often!

~Kate~ Thanks!  I agree.  It is not JUST a particular interest rate that makes a program wrong or bad - heck, look at your credit cards ;)  Thanks for the comments!

Aug 19, 2007 04:53 AM