Will 2013 Bring the Return of the Subprime Mortgage?

Mortgage and Lending with iLoan - NMLS ID#4474 NMLS 79048

Fear, regulatory uncertainty, market instability and a lack of consumer confidence has kept the reemergence of these products at bay.  Make no mistake though; the money for these products is there.  Reemerging market stability has helped to abate the fears of some mortgage investors on the secondary market.  Consumer confidence has not recovered but it is up.  The big issue has been regulatory clarity.  Two significant events are unfolding that are likely to bring that to an end.

The first is the move by the FDIC to provide the new definition of subprime mortgages.  The first thing they did was rename subprime loans as “Higher Risk Consumer Loans”  LOL!  Yeah, . . . that’s going to stick.  These higher risk assets are defined as the sum of construction and land development loans, high risk commercial/industrial loans, leveraged loans, subprime loans and non-traditional mortgage loans.  They will be defined by Probability of Default or PD.  The new subprime, or should I say Higher Risk Consumer Loans (tee hee hee)  will be loans that have a probability of default being higher than 20% over a two year period (default being 90+ days late, bankruptcy, charged off, gone to collection or worse).  Why would banks want to make loans like this?  Because believe it or not, they’re profitable!

This FDIC proposed initiative will go into effect this October.  Perhaps the most onerous part of this rule will be the reporting component but it won’t take long before the large banks affected have it all figured out.  When they do and their balance sheets support it, it’s likely they’ll look to expanding credit product offerings.  That is, . . . after the second part of regulatory clarity is in place.

The second major regulatory clarity will come before the end of the year when the Consumer Finance Protection Bureau defines a Qualified Residential Mortgage or QM.  The qualified residential mortgage provision, from the Dodd-Frank law, forces banks that issue mortgage-backed securities to retain at least 5% of the value of the portfolio on their own books.  In this, the CFPB will and is contemplating thresholds on elements of loans such as Loan to Value, Debt to Income Ratios and other loan feature used to evaluate risk.  I’m a CFPB fan but this is pretty creepy to watch happen because the ramifications of mistakes on the housing industry will be mind-blowing should any be made.  One thing is clear, the chips will have fallen and large institutions will know what type of loans they can offer without constraining their cash reserves.  More importantly perhaps, when their balance sheets are flush (and some already are), it will let them know how to evaluate mortgage securitizations that they would have to hold back cash reserves on but might want to make anyway.  Why would they want to make loans like that?  Because it’s profitable!

This could be a good thing.  Let’s say a buyer had a short sale but otherwise had a fantastic borrower profile.   Great cash reserves, strong income, low debt and a 25 percent down payment.  Why wouldn’t a lender give a loan to that person after one year from the short sale closing knowing that they might qualify to refinance into a Fannie Mae loan under the extenuating circumstances rule after one year or refinance into a FHA loan after 2 years.  In the meantime, that lender makes great fees on giving the loan and an excellent spread on the rate they give on the loan.  Oh and let’s not forget that getting strong buyers into the housing market is a fantastic thing too.  This can be a win-win.  Sometimes, greed is good.

For anyone who doesn’t think subprime will come back, they need only look at how cyclically history has repeated itself.  Late 80’s, . . savings and loan crisis.  Subprime came back.  Late 90’s, . . subprime liquidity crisis.  Subprime came back.  Late 2000’s; well, I think we all remember that.  It seems to come around every 10 years in the mortgage business.  And once again, subprime will come back again because its profitability is just too tempting.  With these two regulatory hurdles out of the way, look to mid-2013 for some strange mortgage products to show up.  With these two rules in place keeping things in check, I’m all for it.

Posted by

Charles Dailey - Branch Manager, Loan Officer, Certified Military Housing Specialist - iLoan - NMLS ID# 79048 -  612.234.7283 - charles@charlesdailey.com

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  1. Gabe Sanders 07/22/2012 09:04 PM
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Gabe Sanders
Real Estate of Florida specializing in Martin County Residential Homes, Condos and Land Sales - Stuart, FL
Stuart Florida Real Estate

Thanks Charles, excellent information.

Jul 21, 2012 10:48 PM #4
Scott Godzyk
Godzyk Real Estate Services - Manchester, NH
One of Manchester NH's Leading Agents

I agree they do have the money, they are just not loaning it. I would love to see a mortgage for self employeed people come back.

Jul 21, 2012 11:07 PM #5
Amanda Christiansen
Christiansen Group Realty (260)704-0843 - Fort Wayne, IN
Christiansen Group Realty

Great article Charles.  I sure hope that subprime lending doesn't come back.  That's part of what got us in trouble in the first place.  I guess it is all about the money though...  

Jul 21, 2012 11:07 PM #6
Bryan Robertson
Intero Real Estate - Los Altos, CA
Broker, Author, Speaker

I'm already seeing people get loans that fit the definition of "subprime" and borrowers with very limited funds are getting $1 million loans to buy properties most people couldn't get.  As long as lenders are a little more careful, maybe we'll see fewer defaults.  As it is, the old days are back.

Jul 22, 2012 12:11 AM #7
Melissa Zavala
Broadpoint Properties - Escondido, CA
Broker, Escondido Real Estate, San Diego County

This was very interesting. I guess that is why they say that history always repeats itself.

Jul 22, 2012 12:17 AM #8
Richie Alan Naggar
people first...then business Ran Right Realty - Riverside, CA
agent & author

I have no doubt that it exists and may surface once again....For the wise, it will mean they learned their lessons. For the foolish, well it is time to revisit the situation...good post

Jul 22, 2012 12:47 AM #9
Ben Gerritsen
Mortgage Miracles Happen, NMLS ID: 1289680 - Ogden, UT
Mortgage Loan Originator

There's a time & a place for the loans. I know business owners & some self-employed that these loans fit. They are the ones that need them. Also, those that have substantial income, it is verifiable, job history is great and they have gone through a challenge & don't qualify based on conventional or FHA guidelines right now.  There's a time & a place for these products. I agree that the money is sitting on the sidelines and not just a little bit of money, but plenty of funds.

Jul 22, 2012 01:51 AM #10
John Juarez
The Medford Real Estate Team - Fremont, CA

For those who decry “subprime” mortgages on their face, we must remember that a subprime mortgages is a product that, properly used, has a legitimate place in the mortgage universe. There are borrowers who are the proper beneficiaries of subprime loans due to the character of, among other criteria, their property, their equity position, their credit standing, their ability to repay, their source of repayment or other criteria. Not every borrower and not every loan situation are deserving of a low rate, 30 year, fixed rate mortgage. Lending is a risk-based business. Borrowers have a variety of risk profiles. Higher risk borrowers can expect to pay a premium for loans (higher rate or fees or both) including subprime borrowers.

Predatory lending using subprime loan programs is another matter altogether.

Jul 22, 2012 03:49 AM #11
Janis Borgueta
Key Properties of the Hudson Valley - Newburgh, NY
LIC RE Salesperson

The banks will prevail and make huge amounts of money no matter what. Greed  the banks rule.. 

Jul 22, 2012 04:13 AM #12
Melissa Marro
Keller Williams First Coast Realty - The Marro Team - Orange Park, FL
Jacksonville Real Estate and Home Staging

It has to happen because there are so many people who have had short sales and forclosures that taking all of them out of they buying pool for 5-10 years would be suicidal to banking. Instead it is in their best interest (and that of the general housing market) to begin making "high risk" loans (hopefully with down payments and solid income statements). 

Jul 22, 2012 04:28 AM #13
Sandy Acevedo
951-290-8588 - Chino Hills, CA
RE/MAX Masters, Inland Empire Homes for Sale

Hi Charles, great post! And using Michael Douglas' pic for the greed aspect is so apt. Well done!

Jul 22, 2012 05:03 AM #14
Pamela Seley
West Coast Realty Division - Murrieta, CA
Residential Real Estate Agent serving SW RivCo CA

Charles, I agree this is an excellent post. There are those who make profit by taking advantage of others' ignorance. Some homeowners have learned their lesson, and others who don't know, will learn theirs. Can you tell I'm skeptical?

Jul 22, 2012 07:09 AM #15
Gary Frimann
Eagle Ridge Realty / Signature Homes & Estates - Gilroy, CA
REALTOR and Broker

I've called for the retuen of subprime for a coouple of years.  HOWEVER-- no more 100% State Income Stated Aasset loans.  Subprime is OK for a lower than average credit score with a big enough down payment.  Too many people walked away with 100% financing and the market dropped.  I think it would help prop up the market these days.

Jul 22, 2012 08:02 AM #16
Eric Michael
Remerica Integrity, Realtors®, Northville, MI - Livonia, MI
Metro Detroit Real Estate Professional 734.564.1519

It's going slow so far, but I can already see the loan limitations relaxing. I don't know about sub-prime levels, but things are creeping that way.


Jul 22, 2012 12:06 PM #17
Sharon Alters
Coldwell Banker Vanguard Realty - 904-673-2308 - Fleming Island, FL
Realtor - Homes for Sale Fleming Island FL

Charles, I have wondered when they would be back. There are many credit worthy people being held back due to a short sale who would jump on a subprime "Higher Risk Consumer Loan."


Jul 22, 2012 01:02 PM #18
Christine Donovan
Donovan Blatt Realty - Costa Mesa, CA
Broker/Attorney 714-319-9751 DRE01267479 - Costa M

Charles - I think the market is crying out for subprime, and I agree it will be back.

Jul 22, 2012 04:29 PM #19
Ed & Tracy Oliva
West USA Realty - Arizona - Fountain Hills, AZ
The Oliva Team Arizona Agents

WOW!!!!!!!!!!!!!!!!!!!!!!!!! This is some good Info for all,keep up the good work and good luck in 2012,  E

Jul 22, 2012 10:36 PM #20
Glenn Freezman
Family Abstract, Inc. - Horsham, PA

ARE you kidding me????  The subprim market NEVER left it was taken over by the Government, by me and you, the taxpayers!!In 2007, July, the Feds dessimated the existing root off all evil and replaced me and you in the hot seat!.   Subprime has never left, it just switched faces.

Jul 23, 2012 12:02 AM #21
Brent & Deb Wells
LivingWell Properties - Prosper, TX
Prosper TX

Hi Charles,

Follow the money, best advice ever given. People are creatures of habit and have extremely short memories. I have no doubts it will be repackaged and return...


Jul 23, 2012 01:06 AM #22
Paul McFadden
Paratex - Seattle, WA
Pest Control, Seattle, WA.

Charles: 2013 may be a bit soon but I agree with you. The market will bear those again at some point. Thanks for the post!

Jul 23, 2012 03:38 AM #23
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