Here is my understanding.

Subprime loans really meaning less than optimal ( I initially thought it had something to do with the prime rate! ) are for those with credit challenges/problems.

The rate is higher than normal because of the higher than normal risk the lender is taking by lending to those with a history of poor pay, no pay, etc.

Many consider these loans as predatory in that the subprime lenders advertise their product in poor black/latino neighborhoods.

QUESTION????

I don't see anything inherently wrong with charging the higher interest rate, or advertising to your niche market. Are they considered predatory because they prey on the lack of knowledge the potential customer has of the loan market and process?

I don't see the advantage, for the lender in lending money at any interest rate to people who are likely to default. Is there some hidden profit in people defaulting on loans?

Once someone has established a good payment history on a subprime loan, is it possible they can refinance to a traditional loan?

I do apologize in advance if the answer is obvious, but I do not know it. Please correct me where I am wrong.


Thanks in advance!!

Rates are based on risk. The rates are usually higher for you higher risk clients.

Risk Factors include:
Credit Score
Loan to Value
Income Documentation

Many of these sub prime clients can refinance with betters terms after a couple of years if they are pointed in the right direction on how to clean up their credit.

Also some properties represent higher risk to the lender such as rural areas, etc.

Subprime lending gives people an opportunity to become homeowners who otherwise would not have been able to. Yes ideally they will take 24 mos or so, make their mortgage payments on time and get their act together so next time around they can get a good rate.

The whole argument right now about *predatory* is really irksome to me. We can't be the borrower's parents, all we can do is make sure they fully understand all the terms of the loan and it's all there in writing, believe me.

I also hear the argument that if people have bad credit they shouldn't buy a home. Well, what is the alternative? Keep renting and paying the landlord's mortgage instead? The reality is that paying a mortgage on time is the biggest boost to FICO you can get.

I personally resent the notion that loan officers *target* certain minorities or some such. Perhaps some do. But as one who has the capability to loan to subprime borrowers, I *target* borrowers w/lousy credit and try to get them into loan programs that make sense.

In fact I have some excellent FTHB programs that charge very reasonable and competitive rates even for 500 and below FICO's. But they will have to pay PMI, which at least is now deductible for most FTHBs.

To look at it another way, would it be fair if someone w/horrendous credit pays the same rate as a borrower with a 720? I don't think so.

No lenders do not want the property to go into default. The current round of foreclosures cannot fairly be blamed strictly on loan officers/fraud. The current Admin in DC made it a priority to increase home ownership. And lenders miscalculated the market thinking values would cont to increase up and up and up forever. As long as property values rise, lenders have less to fear from foreclosure.

But the market tanked in many areas, borrowers got into loans they couldn't really afford and thus disaster strikes.

So I agree too many loan originators are guilty of fraud and deceit, others in the process have responsiblity as well, esp the borrowers.

Please don't sign up for a loan if you don't understand it fully!

And where are the underwriters in all of this? It is their job to catch red flags in the loan package.

And the appraisers? The last round of fc's back in the 80's-90's largely resulted from inflated appraisals.

So subprime loans can be a blessing to those who truly want the opportunity to become homeowners and will use that chance well or they can be disastrous.

In any case, it's all about to change anyway. The biggest problem loans thus far look to be the stated income loans so be prepared for LTV's to go down on those. Interestingly the no docs don't seem to be the culprit rather the stateds which do seem to create an incentive for dishonest folks to play make believe.

And fwiw I do provide credit counseling to my loan applicants in hopes of getting them into the best possible program.

I think something that we all lose track of is that there is actual real hard cold cash that is being written for the customer to obtain a loan. Because we never actually see $200,000 sitting on the table we just assume it is just some paperwork and that’s it. Lenders are going to protect their assets by charging higher rates based on the likelihood the client will not make payments or foreclose.

It is funny when you hear people complain about their interest rate or payment. If it weren’t for Lender X taking the risk of giving this person a loan there would be nothing to complain about except maybe the landlord or rent payments to high. There would be no last minute stips or missing wires or delayed closing because the customer would not qualify without lender X taking the risk. There would be no angry sellers or frustrated realtors or buyers with a moving truck full of all of their belongings because there would be no loan.

People in this industry use the word predatory far to often to describe a conventional lender. Don’t forget that interest rates were 18% during the 80's and people were still buying. Does that mean everyone that bought a house was ripped off? FHA and VA rates were thru the roof. So were the Govt loans also predatory?

Risk is the answer to all of the loan programs and rates for all levels of buyers. The lower your score, the less proof of income, the smaller the down payment puts the lenders actual money at risk. High-risk loans have higher default rates so to continue to offer a product to the % of homeowners that do pay their bills the lenders adjust their interest rates accordingly to cover the losses.

Legislation and people talking about loans that they don’t understand is going to close the door for some good people to have the opportunity to become homeowners. Some really good lenders and some great programs are going away everyday, and it will hurt all of us in the long run. It is really sad to me to see the 100% financing go away. Stated income and NoDoc loans served a purpose for the right people, and they have been abused.

You will have to forgive me getting on my soap box, but I am tired of rrading the paper and watching the news and some idiot is trashing something they dont even understand. If I have to listen to Suze Orman open her mouth again about how dangerous Interest Only loans are I will fly thru my TV. She does not know what she is talking about. Has anyone ever seen an Amortization Schedule?

If you have a $200,000 loan on a 5/1 or 10/1 Fixed/ARM @ 7% principal and interest payment you will have payed $11,969.22 with a payment of $1330.60 that is a whole whopping 6% which should cover the realtor fees so they can sell as most homeowners keep their loans from 5 to 7 years. The Interest Only payment fixed for the same amount of time would be $1,166.67 which is a monthly savings of $163.93 x 60 months= $9,837.60 cash in hand or directly reduced from principal. Plus the home appreciates at least 3% year, which is $231,854.81. With the interest only payment your payment is based on you balance not a 30-year term. So if you contribute the $163.93 a month savings your minimum payment in 5 years would be $57.39 cheaper. To many uneducated people running their mouths about something they don’t understand. So tell me how something like Interest Only for example can be considered Predatory Lending?

If you have a previous history of not paying your bills than you will get a higher rate than the guy that does pay his bills. If you don’t put any skin into a house than you will pay more to finance it. If you cant show how you make your income because you write it all off at tax time so you can pay less taxes then you will pay more to finance. If you cant prove your previous rent/credit history than you will pay more to finance.

When people come to me and talk about how they don’t have a down payment, and my rates are to high it drives me nuts. Then you pull their credit and they make $40,000 a year and have a $600.00 a month car note at 18% interest and they don’t have a problem with that. People have their priorities mixed up.


Just my 2 cents and a ramble

Amen, TN Mortgage Broker!

Oh yeah, I've had FTHB's w/no provable income and 487 FICO literally *demanding* a low 30 fixed rate.

But ask what the monthly payment is on that 56 in TV they could not have lived without . . .

Those foul TV ads don't help us much with the fake interest rates, and *no appraisal fee, blah blah blah* Hint: those TV lenders are not social service agencies, the borrower will pay all those fees and more . . .

My post clearly hit a sore spot with everyone, but what I am trying to figure out is

1. Right or wrong, why are subprime loans considered predatory?
Charging a higher rate for a more risky loan seems quite normal IMO. Is there something I am overlooking?

Subprime loans are not considered predatory. Certain practices that accompany subprime loans are. There is nothing predatory about charging 9% to a borrower who qualifies for 9%. However, the subprime market is crumbling because:

1. Many borrowers requiring subprime loans are more needy, and thus more likely to be conned by a fraudulent loan. Refinancing such a borrower repeatedly over the course of a few years and charging high points each time can strip the home owner of equity. Failing to properly disclose a prepayment penalty to a client who who likely only need the loan for 12 to 24 months is wrong. Inflating an appraisal (this is the fault of the appraiser, but it is ultimately attached to the loan) in order to pull more money out is wrong. Stating a higher income for a borrower who will likely not be able to pay the mortgage payment is wrong. Making these practices the cornerstone of your business is certainly predatory. On forums like this there are so many excellent, highly skilled loan officers, that this topic can get peple heated. We hate predatory lending and would love to see it dissolve in any and every form.

2. Subrpime interest rates have been TOO low, and the program guidelines have been too loose. When honest loan officers utilized these programs to help borrowers achieve the dream of home ownership only to have countless borrowers default, the media screamed "predatory lending!" It's a shame, really. And it is a misunderstanding. Had the banks responded more quickly to the marketplace and removed the poorly performing programs, perhaps this topic never would have arisen.

Regarding your point about marketing poor neighborhoods, I think it is both safe and fair to say that every professional is entitled to his/her market. Targeting a minority market is deemed predatory. Avoiding a minority market is deemed racist. All of us in the real estate industry should be proud to reach into every community and offer our services. Subprime loans, when effectively utilized, are also something we should be proud to use as one of many tools for increasing home ownership and opportunity in this country.

Subprime loans are not predatory. Unfortunately, some people are.

Okay that explains it. Thanks.

As I have said before, charging higher interest or marketing to a niche--poor, rich, FTHB, black, latino, white -- in and of itself is not predatory at all. Plus subprime loans are only responding to a sitation created by the borrower.

But the word predatory is often used when discussing subprime loans and I needed to understand what was the issue.

Just as with anything, there are a few who spoil it for the many.

Thanks again!

Wow! I am glad this topic came up otherwise I'd not have known we had such outstanding and articluate LOS here!

So true, many of us absolutely detest the sleaze that goes on in our profession.

Another subprime followup.

Someone mentioned the 'subprime market is about the change anyway.' I have seen others say it is going to 'collapse'. Either way it sounds disasterous as when I hear the word collapse I think panic and terror as in Wall Street collapsing.

Would someone please explain the forthcoming changes or collapse?

Subprime guidelines are literally changing by the hour. Since I work with 200+ lenders, that's a lot to keep track of!

The subprime loans are simply not performing, defaults are up as most agents know.

Some lenders have gone under completely, some are in BK.

Others will survive, esp those that have not built their entire empires around subprime borrowers.

But it will absolutely change.

First on the chopping block is the stated income loans, those thus far are the worst performers. The straight no docs are not doing as badly.

I expect rather than the complete elimination of subprime lending, the trend toward tightening guidelines will continue, esp in the area of loan to value ratios.

Wall Street is being affected by this as REIT funds are traded on the market.

ReallyReal,

I started doing mortgage lending in 1996 with a sub-prime lender. It turned out this was the dawn of a liquidity crisis that struck the sub-prime secondary market through early 1998. I was only a loan officer and didn't understand what happened to a loan after it was sold.

Later in my career, I spent 4.5 years working in secondary marketing of mortgages and better understood what had happened in 1998 and how the market has changed. Here's my take on the future of sub-prime.

1) The number of mortgage lenders doing ONLY sub-prime lending are contracting and it will get worse for them. In 1998, sub-prime mortgage backed securities were traded outside of the typical MBS market and were rated similar to junk bonds. All it took was a little bit of risk in that segment and new capital dried up.

Today, sub-prime loans are much more diversely securitized. Fannie Mae and Freddie Mac's participation in buying subprime loans the last couple of years means that some sub-prime loans are tucked into conventional MBS issues.

Your true sub-prime securities are getting crushed right now and that means those lenders who ONLY do sub-prime and can't diversify that paper are hurting. You can see why H&R Block is trying desperately to divest themselves of the financial albatross that Option One (a subprime wholesale lending company) has become for them.

2) The choices in sub-prime loans will diminish. Probably the biggest change you will see between now and next year is a MAJOR reduction in the use of 2/28 loans (2 year fixed rate loans). Federal regulators are looking at requiring lenders to qualify applicants on a 2/28 loan at the fully indexed rate after the first adjustment. Let me put that in numeric terms.

A 2/28 loan today could be at 7.00% for 2 years, often with a penalty for paying off early. What regulators are considering is requiring the buyer qualify at the rate which this loan will change to after 24 months. That same 7.00% 2/28 ARM would adjust based on the 6 month LIBOR (5.420) PLUS a margin of 6.00%-7.00% and a 5% cap on the first adjustment. That means the rate would go from 7.00% today to 11.42% at adjustment if the LIBOR stays the same. And regulators want to require lenders to qualify the borrower at that 11.42% rate.

The impact will be to kill the 2/28 in favor of the 3/27 which is probably .50% higher in that start rate for the first 3 years.

3) Lenders who have diversified and do all kinds of mortgages are best positioned to absorb these changes and continue to put the "top echelon" of sub-prime loans into less risky securities.

4) In the short-term, mortgage brokers will be hurt hardest. Because lenders are increasingly taking losses on sub-prime loans, they are more likely to have more conservative guidelines for loans brokered to them vs. those originated by their own employees.

I've already seen several examples of loans that brokers can't get approved but the broker is "losing" the deal to the same company through their retail group. There is no secret that loan fraud has a higher incidence rate in loans attained via a broker vs. their own employee (loan officer) which is why investment property financing has been harder of late although there have been hardly any guideline changes.

ReallyReal, the biggest difference I see in this market over 1998 is that today, the largest sub-prime lenders are major financial institutions. If Option One were a stand-alone company they would be having a fire sale in my opinion. Because they are owned by H&R Block they have resources to make it through a short-term "hit".

Long-term, sub-prime lending won't go away becuase it is a much needed segment to provide homeownership opportunities. If Congress will allow HUD to lend to 100% that will really cut into sub-prime lending initiatives and offer a true low-rate and cost alternative.

Write your congressman!

I heard today that New Century Financial is closing. They are a BIG player in the subprime market! Freemont says they aren't doing anymore secondary financing, Novastar is struggling and it's not hard to see the crash of the subprime lenders very soon. This will rival the S&L scandals of the '80s.

I'm gettin emails literally by the hr from our various investors w/guideline changes.

Our co is continuing to do subprimes tho the pool of lenders is smaller and we will no longer fund the transactions, we will wholesale them using our broker rather than banker capabilities.

So everyone is adjusting some will adapt others will crash.

I suspect the feds will drop rates in May to help avert a bigger mess than we already have.

Tho I think perspective is important, the subprime market is still a small % of the total mortgage business. Some lenders only did subprimes, they're in trouble. But overall the % nationwide is not that huge.

Oh and I did want to address the possiblity of FHA going to 100%, yeah it sounds good but . . .

Guess who is really gonna pay when *those* subprimes go south? Yup, you and me and every other taxpayer.

Anyone have any insight into the private MI co's? Do they have the capital to cover the impending tsunami of defaults?

Good question Loan Diva. You'd have to think that several Insurers are going to go bankrupt as a result.

I'm wondering if we'll see a whole bunch of sellers carrying seconds on properties. That might be the only way to sell homes to people without prime credit.

We're seeing more and more seller carrys around here tho it can get tricky w/some investors.

It was last yr at a seminar that the possibility came up that some of the private MI companies may be undercapitalized.

Btw we also are not doing anything over 80% on stateds; business as usual on no doc and full doc.

The biggest reason your stated income has gone south is the fact that Fannie and Freddie aren't buying that paper any longer. No Ratio and No doc were securitized under Alt-A securities and those are still performing fairly well.

Some of this is reactionary and some is fall-out from the GSE scandal of 2005. It will settle out. In the meantime, we are due for a small correction to 100% sub-prime financing and it's a good idea for housing and for homeownership if we pull that back a little. When FHA had a market share of over 12% it was a better balance of less-than-perfect credit. As FHA has slipped to less than 4% it means too many fast and dirty sub-prime deals got written with bad appraisals, shoddy documentation, etc. Too many subprime companies competing for volume and not holding to their own guidelines.

The writing was on the wall so none of this should be a surprise.

But going back to the old "seller-seconds" days? Oh, my that brings back memories.....

Ack as long as we don't go back to those awful AITD and other risky scheme days!

Diva,

Do you remember the days of asking a customer to go to the Moneystore or Beneficial and take out a 5% unsecured loan for their down-payment? Sub-prime old-skool style.

Nope but I do remember many *xperts* comin out of the woodwork w/magical schemes for letting buyers assume non assumables which basically was always some permutation of an AITD w/a convoluted interpretation of the law insisting that it would NOT trigger the due on sale . . .

Let's see, assuming a 7% loan in a market where 10.75% was considered a great rate . . . anyone else remember those days?

For use Real Estate agents that don't know? Would you be kind enough to explain what "AITD" means.

thanks
ron

Oh sorry! I am giving away my age by even talking about this! We haven't seen these in ages: All Inclusive Deed of Trust. Also referred to as a *wrap around* mortgage.

Here in CA virtually all purchases are by way of a deed of trust. The AITD was an attempt to circumvent the non assumability of loans by letting a buyer step in and take over a loan w/o the lender's consent and hoping not to trip the *due on sale* wire.

Typically the seller would take a 2d to cover his/her equity and *wrap* the whole thing into one.

That was back in the day when interest rates were going up by the hour, I recall some friends who were deleriously happy getting a rate lock at 10.75% on a 1st!

So the older loans which were written in the 7% range were attractive to buyers but many were non assumable or could only be assumed by qualifying the new buyer and paying an assumption fee and numerous other hoops b/c the lender had no motivation to let those loans be assumed at the old rates.

The whole AITD thing was a fraud on the lender tho many attorneys made bank coming up w/supposed loopholes.

I haven't seen a wraparound, only read about them. You must be much older than I am :P

Yes this was the same time as the dinosaurs were becoming extinct . . . : P

Wrap-Arounds are pretty popular here in CA in regards to creative financing. Investors here love these Seller-Carry loans but the Due On Sale clause is something that not too many are familiar with.

Good post, Diva!

Are you guys still seeing AITDs in your area? Wow, it's been eons for me. Tho we're seeing more seller carrybacks w/new loans.

I am seeing quite a few and maybe it's because I work with a circle of investors. I rarely run into AITDs when working with a client that isn't an investor. Seller Carrybacks will be even more popular as lending guidelines become tighter.IMHO

You do not have to be ancient to know what the AITD is. It is one of the questions on the California DRE exam.

Don’t forget about the big players eliminating their competition.