There’s No Love for the Subprime Borrower
Rhonda Porter on 02 13, 2007
It’s all over the news, we’re hearing about major subprime lenders having to restate their losses and every day, lenders are coming into my office to inform us of changes to their guidelines. This is all good, right? It will be tougher to provide loans for home buyers who maybe should be spending more time to learn about budgeting and using their credit cards. What about the people who are all ready in these programs?
First, allow me to explain the basic dynamics of these loans. Many of these mortgages are zero down, 80/20s (80% of the loan to value for the first mortgage/20% of the value for the second mortgage). The first mortgage is typically offers a fixed rate for 2-3 years with a prepayment penalty (the standard is six months interest) that matches the fixed rate period. In addition, the mortgages may be interest only or amortized at 30, 40 or 50 years. The rates on these mortgages are completely dependent on credit score.
When I meet with Mr. and Mrs. Subprime, I advise them of their options of buying now using this type of subprime mortgage or that they can work on their credit, job history, etc. and buy later with a better mortgage program. Because there are no guarantee of what rates will be (or maybe because they know there’s not guaranteed they’ll clean up their act) and because they want to buy a house now, they often opt for the subprime mortgage. Once this happens, I heavily stress (or Jillayne would say, I lecture 
—which I’m sure I do) to Mr. and Mrs. Subprime that they have 2-3 years to change their spending habits because once their fixed period rate is over, their mortgage is going to adjust and do so big time. I let them know that I want them to be in the best position for a refinance into permanent financing (or to have a better mortgage should they decide to sell the home assuming they have any equity) and that the subprime mortgage they are using to obtain their home is temporary financing.
Many of my clients in these mortgages have done very well and I’m proud of them. They have taken the responsibility of owning a home and having a mortgage to heart. I’m able to restructure the original mortgage and improve their situation greatly. The concern is for Mr. and Mrs. Subprime who just didn’t get the hang of it. They continued to charge up their credit cards, they bought or leased a new car to go in their new driveway and maybe a new TV, too. They’ve been sliding ever since the holidays and are now having a tough time paying their mortgages on time. Maybe they just have one mortgage late. Their credit is rough at best. Their fixed period (and prepayment penalty) is over and now they really need to refinance fast because their mortgage has adjusted for the first time—their rate is now 2% higher. Their situation has gone from bad to worse. With all the tightening in the subprime market, even if their credit scores and scenarios are the same as when they bought, there may not be a program for them to refinance out of now. They will be forced to sell (hopefully they have enough equity to pay commissions and other closing costs) or to somehow manage to choke down their increased payments.
I guess this post is a plea of sorts. If you currently have a subprime loan (especially the type I described) please contact your Mortgage Planner to have your credit reviewed to make sure you’re on the right track to be able to refinance (or have a better loan for when you sell) when the time is due. Do not assume there will be a program for you if you have not made significant changes to your spending and use of credit cards. If you’re a real estate agent or loan originator, check in on your subprime clients to let them know of the changes in the industry…see if they need guidance to stay or get on track so they don’t wind up stuck with a higher mortgage payment, being forced to sell or foreclosure.
About the Author: Rhonda Porter
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24 Responses to “There’s No Love for the Subprime Borrower”
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Rhonda…once again…you post valuable advice. I don’t have time now but hope that you will permit me to ask a few questions and pose a few “what ifs”.
One quick question…are the ARMs that you refer to fixed for a 3 year period on average before adjustment?
I’ll be back tonight.
EconE -
Our office has closed numerous ARM’s: Option Arms, 1 yr ARM’s (Most based on LIBOR Index), a lot of 2yr ARMS, 5 yr fixed I/O products and of course, many with pre-payment penalties. Recently though, I have seen a clear shift towards longer terms, 5 yrs and 10 yrs. With a 10 yr I/O product, the first ten years is fixed, with an interest only payment until the adjustment date. So, the saavy borrower reduces short term payment fluctuations and can realize the potential gain of equity (both by paying principal during the period and market appreciation) over a long period.
Hi EconE, I’m not sure I understand your question. I’m assuming you’re asking me what the rate is on average? I just did a quick breeze-through of my database over the past two years, it has ranged from 5.6% – 9.65% (remember, it’s credit score based) with an average of 7.1%. Typically, the second mortgages are from the high 9s to 11%.
I did not tally everyone and this is far from scientific.
Tim, are all of the loans subprime? It’s the short term ARMs (2-3 years) with the prepays at 100% financing that is going to bite a lot of home owners.
What rates are you seeing Tim?
There has been a shift toward longer term loans and for good reason. The Fed has been raising short term interest rates on for how long now as a strategy to slow inflation? Long term interest rates have not risen in the same fashion. The Fed has no control over long term interest rates which follow the bond market. The bond market yields are based on supply demand of investor’s fears of inflation. In the last few years, more of the US bonds are purchased by foreign investment indicating less fear of inflation. The long term rates have increased a small amount, but remained stable for the most part. Generally, investors expect long term rates to be higher than short term rates because of inflation risk and investment risk for the longer time to maturity. Long term rates are comparable to short term rates. When the cost of money or effective interest rate (APR for lenders) is the same why not borrow longer?
Interestingly, we have experienced an inverted yield curve a few times over the last two years. An inverted yield curve is the situation where short term rates are higher than long term rates. In the past many economists believed an inverted yield curve was a precursor to an economies recession. I don’t think that is the case anymore because we have greater global investment and influence on our economy.
Cheers,
Michael P. Lindekugel
Financial Analyst
RE/MAX Commercial
Team Reba – RE/MAX Metro Realty, Inc
I haven’t seen big spreads between the 5/25 and 7/23 options in years. Can someone quote:
5/25, 7/23, 10/20, 30 and 40 for us? I’d love to see these five every week. Assume 20% down and a 720 or better Fico and I’ll adjust from there.
Thanks.
Are you tasking me, Ardell?
Balloons (5/25 and 7/23) have not been as popular as their counterparts, 5/1 and 7/1 ARMs. Plus with the inverted yield curve, ARMs have not been as competitive as 30 year fixed rates.
On Wednesdays, I try email a rate sheet out…I would be all too happy to post rates on RCG.
Please do. Fridays are great, right before the weekend when lots of offers are written or when people are out and about going to Open Houses.
What’s the spread on a 5/25 vs a 5/1? I agree when rates were down in 2005, the balloon products lost interest. But as rates are up, I’m thinking someone who knows they will not stay for more than five years might do a 7/23 if the spread between that and the 30 were good enough and the spread between the 7/23 and the 7/1 were good enough as well.
I like to see the spreads. It’s the only way I can tell what’s really happening, so add the 5/1 and 7/1 to the 5/25 and 7/23 request.
I only qualify people at minimum 5/25 or( 5/1). Anything less than five years is between lender and consumer, and not for purchase price evaluations. In fact I mostly qualify at 30 year, and then if they want to do stretch price by going with a five year, they have room.
I like to qualify from the trenches as HOA dues and Taxes can vary greatly, so I have to adjust price accordingly from one property to the next.
What’s the rate for PMI by the way? I think using 5% down and PMI might be coming back for qualifying purposes, and then if people want to do seconds instead, that’s between lender and consumer.
Questions for whomever,
(1) When someone says ‘excellent credit’, what FICO score is really the target? I’ve seen excellent be anything from 700 to 780+. Is there really a lender difference between someone with a score of 710 versus 740 versus 770?
Thanks, Lesley
I don’t think that it is an absolute constant from lender to lender. There is some variance between lenders. I’ve heard “cutoffs” at 580, 620, 660, 720. Some have no difference after 660. Sometimes the cutoffs move.
Would love to hear Rhonda’s experience on this one. When you quote a rate generally, like your rate sheets, what FICO would someone have to have, to get the generally quoted rate? My guess is 660, but used 720 as the assumption just in case.
When I say “excellent credit”, the scores need to be 700 or above. When I quote rates, I’m assuming a 680 score…the higher the loan to value, the more the credit score impacts the rate. Some loans will provide slightly better pricing with scores above 720 (0.125 for example).
interst rate sources
BankRate.com
http://www.bankrate.com/
This website provides data on interest rates and the underlying debt instruments.
Mortgage Bankers Association
http://www.mortgagebankers.org/
Cheers,
Michael P. Lindekugel
Financial Analyst
RE/MAX Commercial
Team Reba – RE/MAX Metro Realty, Inc
I would never trust bankrate.com for interest rates.
They were sued for “bait and switch” tackets with advertising mortgage rates.
http://internet.seekingalpha.com/article/18401
They did settle for a cool $3mil.
What makes a lender a subprime lender?
What I’m asking is almost all mortgage lenders originate some loans that are at subprime rates, so is there some standard that defines what a “subprime lender” is?
Rhonda,
I’m chiming in on cb’s question.
One of the worst things I saw was a doctor who was referred to his friend’s lender without knowing that the lender could ONLY do Sub-Prime. It was two days before closing when they got their Good Faith Estimate and saw the high APR. I don’t want to say I looked at that GFE even though they weren’t my client. Don’t want to start another is it OK for Ardell to peek at something, for a non client, discussion.:)
Thanks, Ardell. I think maybe a different way to look at cb’s question is: is there a standard that defines what a subprime loan is? Both questions can be tricky to answer.
As far as lenders go, some only do “a paper” loans (requiring a certain credit score and/or amount of equity/down payment). Many lenders will do both. There’s also “alt-a” and a wide range of other types of loans and lenders for those borrowers who do not fit into the “a paper” category. I believe a correspondent lender or broker would offer a larger selection. Many banks have products that are subprime too and/or would refer you to one of their “sister” companies that offer these types of loans.
I agree with Ardell in that I would not go directly to a subprime lender (or a lender who only does b-paper or lower). Just last week, I had a client close on a purchase who believed she was subprime from the lender (bank) she was working with. We were able to close her loan easily as “a paper” which saved her substantially on her interest rate. Had she gone directly to a “subprime” lender, her rate would have been even higher than what the bank was going to provide her.
Subprime mortgage meltdown…
The slowdown in real estate is seriously affecting the mortgage market with some suggesting a meltdown…
Rhonda,
Wow, 16 messages and no one has connected the dots between the problems in the subprime market and your willingness to put “Mr. & Mrs. Subprime” into a loan that they have no hope of servicing once the rate reset kicks in. Guess what folks, we have met the enemy and it is us – brokers putting clients into loans that are bound to default on barring some prodigious rate of HPA or some sudden income windfall (and remember these subprime loans usually reset in two years). Yes, I know you are only selling loans that are approved by the lenders. But this wink-wink behavior of everyone in the mortgage food chain is putting over-their-heads borrowers on a course for a train wreck two years down the road and is at the root of what is causing the mortgage industry headlines everyone is reading.
Well folks, enjoy the easy subprime fees while they last. In a day not too far into the future, you are going to have to qualify borrowers at the fully indexed rate *after* the interest rate reset. At that point, you will be left with a dramatically smaller market of people who can actually service what they have signed up for. In the interim, think hard about how much you want to push the envelope with these loans. The foreclosures are starting to pile up, hearings are starting to be held in Congress, and before this is over more than a few brokers are going to be doing the perp walk. A lot of people will have their credit ruined and lives turned upside down, and the powers that be will be looking for scape goats. Imagine yourself under oath in front of the TV cameras before you make that next loan.
Bill, “When I meet with Mr. and Mrs. Subprime, I advise them of their options of buying now using this type of subprime mortgage or that they can work on their credit, job history, etc. and buy later with a better mortgage program”. I would NEVER put anyone in a loan if I thought they would default or not be responsible with their credit so they could refinance. Believe it or not, I do like to get my sleep at night and I care very much about my clients. It is the reason for this post–I am warning them and anyone who knows someone with one of these loans that they need to take action NOW to make sure they’re on track for when they will need to refinance.
How could I (or any broker) know that subprime lenders would be closing or misstating losses? I’m glad that you’re pointing out the seriousness of this matter–I agree with you there. However, it’s not always the big bad broker’s fault. Regardless of what type of mortgage someone has (or even if they don’t have a mortgage), people need to be more responsible with their credit and finances.
[...] I’ve mentioned this before, but this is so important. If you have clients who have used subprime financing who have purchased homes in the past 1-2 years, this could be a good reason to pick up the phone and call them. Hopefully they received good counseling from their Mortgage Planner AND they took the advice to heart…working on cleaning up their credit usage, managing their spending, etc. With the subprime market tightening, if those subprime borrowers have credit scores below 620 when their prepayement penalty is up and their fixed payment is adjusting towards the sky, they may be in a very tough situation. [...]
I have a subprime loan thru ameriquest, 7.2% untill 2008. I put down $110,000. so i know i have some equity. I do not have a prepayment penalty. My worry is the fact that today ameriquest sold, and did a huge amount of lay offs ( my sister works for them and was layed off with no notice today) My credit has not improved much it is about 550. my coborrowers is about 630. Should i wait to try and refi untill later in the year? or should i try to find a new loan now. My income is not very high, but I have never had a late payment. (14 months)
Hi Melany, please contact your loan officer as soon as possible to have your credit reviewed. They should be able to guide you as to which debts to pay off and help you with a strategy. A 550 and even a 630 score is going to be very difficult for you to refinance…in fact I’m afraid you will not be able to find a rate better than 7.2%. The “good” news is that at least your rate is fixed until 2008 and you have time to work on your credit. Keep up the good work with not making late payments (especially on your mortgage). And I’m sorry about your sister.
If you need a referral to a mortgage lender in your area, I can try to help you find someone. Good luck!
PS: Melanie, I am doing a series of tips for subprime borrowers at my blog at http://www.mortgageporter.com. Click on “subprime lending” on the left column for the post that would apply. Your credit score is reflective and is not set in stone.
[...] News at 6:00 April 24, 2007 I was contacted by KOMO this morning to see if they could stop by my office this afternoon to interview me regarding subprime mortgages and how it has impacted consumers. [...]