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:
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.
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