"Subprime Loans are Stupid", says the local news financial guru

Mortgage and Lending with Jacob Dean Mortgage

That was the quote this morning on a local news show. If you believe the financial" expert", homeowners just blundered into these bad loans, or were duped into these bad loan products and he recommended people should refinance now into conforming fixed rates loans to get out of these high-rate, subprime loans. . "These subprime loans were stupid", he said. 

 Wow, how do I get to be an "expert" like this? Here's the problem I have with comments like this, especially in the wake of all the press regarding the current real estate market.  I agree that relatively loose lending guidelines and "cheap" money provided home ownership opportunities for some people that would not have qualified for mortgages as recently as 4 or 5 years ago. The untold story is that not all of these were bad loans, not all were sub-prime loans, and not all of these will result in foreclosure. If you believe some of the hype, there are as many as 17 million foreclosures expected within the next 2 years. That number seems incredibly high, since there are an estimated 50 million homeowners, according to recent census data.  Even Senator Obama only predicts 2 million foreclosures, still a historically high percentage.

Breaking down the comments from this morning shows an underlying lack of knowledge regarding the mortgage process. Subprime loans are designed for people who do not qualify for traditional conforming loan products. There is even an interim step down from the traditional "a-paper loan" referred to as "alt-A', or just outside the box A-paper. The most common reason for an Alt-A loan is inability to document income. The most common reasons for subprime loans are (low) credit score and/or mortgage delinquencies. Both of these would prohibit people from obtaining traditional mortgages, sorry to the financial guru. Hopefully the rest of his financial advice is based on better knowledge.

So what REALLY is the problem? Two factors contributed to our current situation: Rising interest rates (actually rising market indices on adjustable rate mortgages) and stagnant or declining property values. Without both of these factors, there would be no panic.  So here was the sales pitch at the time for using an adjustable rate mortgage for a sub-prime or Alt-A loan: "Mr/Ms Borrower, I can get you a 30 year fixed rate on your loan, but I can also get you an adjustable rate mortgage for 1/2 point lower, which means your payment will be $$$$___ lower as well. By the time this rate adjusts in 2 or 3 (or 5 or 7) years, your house will be worth more and you can just refinance into a  lower rate or 30 year rate at that time. This also give you time to improve your credit so that you can qualify for a conforming loan at an EVEN BETTER rate."

Looking at the underlying math, an adjustable rate mortgage is fixed for a period of time, then adjusts based on an index, which can adjust to market conditions, and a (bank profit) margin which is fixed and stated in your original loan documents. As a built-in protection, ARM's have an initial cap on the first interest rate increase, a cap on each periodic increase and a lifetime cap.  Incidentally, these loans also have a floor rate, which is the lowest rate the mortgage can go to in the event the index goes DOWN. The problem with the majority of these loans IS NOT THE RISE IN INTEREST RATES, it is the INABILITY TO REFINANCE INTO ANOTHER LOAN BASED ON PROPERTY VALUE OR INCOME DOCUMENTATION, which is the reason most of these borrowers were not in conforming loans to begin with. These borrowers now face an increase in their payment, which they may or may not be able to pay, and the inability to sell due to lower property values. The contributing factors usually include a stated income loan with little or no down payment originally.

So to our "expert", I would like to say that for the borrowers facing the largest difficulties, the advice to just get a traditional mortgage is not a valid option. You might as well tell them to get a job where they can document all their income, (so sorry for anyone self-employed or who works multiple jobs) or instantly fix their credit (MUCH easier said than done, even when it is possible). BUT, for anyone that got a sub-prime mortgage for the heck of it, when they really qualified for a traditional conventional loan product, he would have been correct...That would have been a stupid loan.


About the Author: Brian Piper is a Senior Loan Officer with East West Mortgage in Vienna Virginia, one of the largest brokers in the country. Also online at http://www.bestvirginiahomeloans.comor http://mortgageblog.bestvirginiahomeloans.com 

Comments (2)

Richard Sweum
1st Security Bank - Everett, WA

90% of the time, people have crappy credit scores not because they don't pay their bills on time; rather it is because they can't pay the bills on time!  Combining the offering of 2/28 loans with lower documentation requirements was simply a recipe for disaster on a larger scale.  Folks that can't manage money, set a budget and live within their means, have no business getting a loan for $2000 let alone $200,000.  Just my opinion...sorry for raining on someone's "American Dream of Home Ownership."

Oct 16, 2007 09:51 AM
Brian Piper
Jacob Dean Mortgage - Vienna, VA

I agree. I just find it odd that those who blame the mortgage companies for taking away homes from people who should (in restrospect) not have qualified for the mortgage don't also place blame on borrowers who can't (because they were not always truthful about income, assets, job history etc ) or don't (because they lack the motivation, discipline, etc ) make the payments.

I see rates all day long, from 1% to 14%. Most of these have NOTHING to do with market fluctuations but EVERYTHING to do with payment history, credit profile etc.  

Oct 16, 2007 11:19 AM