After all the articles and people that I have recently spoken with, there is the general opinion(media has helped with this), that sub-prime loans are evil and to blame for the current mortgage & housing crisis that we are in.
I stand in defence of the sub-prime loan, heres why:
1- Simply, clients did not qualify for conventional guidelines.
2- They were also not FHA eligible yet.
3- Sub-prime's more tolerant guidelines allowed the customer to get the loan they needed.
Now before you shoot me for statement 3, read on.
Think about this: you have a customer that wants to purchase a home for 200K, they have 10% for a deposit on the home for a 90% loan to value 180K loan amount.
Well their score is 575(out for conventional, still okay for FHA),
They also have one 30 day late mortgage in the last 12 months(FHA still possible with letter of explanation)
Their debt ratio will be 46%(with all these factors combined, odds of an FHA loan getting an accept are slim, of course) as a consultant I always look for the cheapest way first, so I would exhaust these programs first before moving to sub-prime.
Side by side comparison: (all loans would be a 30 year fixed)
Lets take those customer above
a 180K Conventional loan at 6%, will be 1,079.19 per month plus PMI.
A 180K FHA loan will be about the same 6% for a 1,079.19 per month plus FHA's mortgage insurance.
180K Sub-prime would be (if the lender did not see this loan as a cash-cow) 9.5% for a 1513.54 payment with no mortgage insurance.
Yes it would be roughly 350.00 more a month. The client now has a choice: either finance now, and refinance to a lower rate later(you must examine if this makes financial sense) or wait until their credit profile is stronger.
When the loan is written as a 30 year fixed, the customer knows right from the beginning what their rate is going to be for the life of the loan.
Now the primary cause for the demise of sub-prime was quite simply, greed.
The factors were:
The ARM: It became the product to push. It allowed for lenders who knew the the customer didn't qualify with a fixed to be able to get the loan with the initial start rate. It is the loan officers duty to give worst case scenarios. (Few did because it slowed the mortgage process or worse, the loan could have been lost).
Prepayment penalties: This was used to lower the interest rate on a the customers loan. Example: without a 2 year prepayment penalty the interest rate would be 9.75%, with the penalty it would be 8.75%(also used as another way to get a customer to qualify). However if the customer either refinanced or sold their home a whopping 5-6 months of interest was due. If you were paying 1,200 per month P & I, you would have an additional of about 5,500 added to your pay off.
Loans done where an 80/20 was used. The first loan was a 8% 2 year ARM and the 2nd was a 2 year 11% ARM. This put the customer in jeopardy immediately, by having a 100% high cost financed program the home owners had where to go if things got bad.
Heavy front & back end charges for doing the loan. This has nothing to do with the customers credit, and has everything to do with running a solid business vs taking peoples money.
Exceptions to everything: This is when common sense wasn't thrown out the window, it was launched off the planet into space. This is when it was okay to send a client with a 62% debt ratio, 95% LTV, fico of 570, and 2 mortgage lates in the last 12 months. If that client say, had a 401K with sufficient funds and other compensating factors the loan could be approved.
Stated: Although this is not exclusively sub-prime, it is a major component in the sub-primes fall. First let me say that I love the stated loan programs for the right person. A good example would be a contractor who gross's 100K per year, but their AGI shows 35K due to deductions. A bad example would be a waitress that works at the local coffee shop and has a stated income of 65K. This is the kind of stuff that was all too frequent in the industry.
I will miss sub-prime(few are doing it) if written correctly these were good loans. Like my specialties of FHA and Conventional fixed, all are tools to get the client the financing they need. It is up to the loan consultant to clearly explain the benefits and pitfalls of any program.
Keep in mind that all loan programs can be abused, but it was a lot easier to do it in sub-prime.
The goal should be to provide education and common sense guidance first, the customer would then have what they need to make an informed choice.
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