The Subprime Slowdown Lowdown
By: jasongolod | Posted: 01st November 2007
Unless you are living in a cave, you have most likely heard something about "Sub-Prime" or "Subprime" mortgages and how they are responsible for the tightened lending policies that we are seeing today. Most homeowners feel that what is going on in the home mortgage lending markets today does not affect them if they are not considered a "subprime" borrower. Unfortunately, this is simply not the case.
So, what is a subprime borrower? The line has been blurred over the past 5 or 6 years between borrower types when it comes to home mortgage loans. It used to be that there were "A paper", "Stated Income" and "Alt-A" borrowers. "A paper" borrowers typically have FICO scores above 700 and are paid on a salaried, W2 basis. Stated income borrowers may have great FICO scores as well, but they do not get a W2, they earn their money via 1099s or other "undocumented" ways. This means that banks and lenders have to use alternative methods to verify that the income the person is stating makes sense. Then there is "Alt-A". "Alt-A" borrowers fall outside of the "A paper" borrower box for one reason or another. They have funky income, credit is a little low, short time working at their current job, etc. This was the "subprime" borrower 10 years ago.
As the US dollar began its steady decline in value, foreign money began to flow into the United States looking for "relatively" cheap US investments. Many foreign investors felt that the US dollar would rebound and that it was a good time to buy things here on the cheap. These foreign dollars helped to make the cost of borrowing money much lower and more importantly, opened the door to borrowers that were never able to buy a home before. This new class of borrower was dubbed, "subprime." These were borrowers with credit below the 620-680 mark, typically stated income, little to no down payment, and with debt-to-income ratios above 40% typically. These were borrowers that no bank would give a loan to 5 years earlier, but with the abundance of money seeking a home in the US, investment vehicles were put together on Wall Street that gave these people access to 100% financing and more.
Many new types of loan programs were created to help these people get into homes and put these dollars to work. After all, an investment banker only gets paid when he puts deals together. With the influx of new borrowers into the real estate market, prices soared as demand went through the roof. 20% down payments were no longer required by for any type of borrower. While subprime borrowers used these high-leverage loans to purchase and refinance their homes, other borrowers did as well. Many used Option ARM or Negative Amortization loans to buy a bigger house than they could really afford. These loans typically have a low start or pay rate of anywhere from 1% to 3% (amortized) and offer 3 to 4 payment "options" a month. Many times, borrowers were allowed to qualify for the loans based on these pay rates rather than a typical fully amortized payment or interest only payment.
Traditional A paper and Alt-A borrowers began to use these loans as well, moving up into bigger and bigger homes and pulling out some of the paper equity they had built up. Unfortunately, many people used this paper equity cash as disposable income, living well beyond their means.
Today we are seeing the effects of all of the over extension of credit the average American consumer has asked for. Almost all of these non-traditional loan programs have been eliminated as they make little to no sense from a lender's perspective, especially when the market is not appreciating. This is where the average consumer may be surprised in the coming months. Many borrowers believe that Option ARM and 100% financing loans are always available. When they go back to their banks or mortgage broker many of these people will be in for a rude awakening only to find out that they will most likely be required to have a fully amortized payment, they will not be allowed to pull cash out and in many cases they will simply not qualify for the loan they are seeking.
The current money crunch is not limited to subprime borrowers. All homeowners should talk to their financial professionals today to assess their current and short-term financial goals and needs to make sure that there won't be any surprises around the corner.
Jason Golod is a principal at Aventine Funding, a a California hard money lender. He also writes articles on a semi-regular basis for ihardmoneyloans.com and other real estate related blogs.
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Tags: abundance, short time, 10 years, lenders, 6 years, borrowing money, fico scores, debt to income ratios, good time, subprime mortgages, mortgage lending, home mortgage loans, foreign investors, steady decline, alternative methods, cost of borrowing, foreign money