Subprime Lending Saga

One topic that is far reaching today is the subprime mortgage market. It has turned the Real Estate market upside down across the nation. What is the subprime market? It is a way for people with a low credit score of 620 or less to possibly get a mortgage. It does have some disadvantages to main stream financing. The subprime borrower is faced with higher closing costs, junk fees, & a higher interest rate. They are able in some cases to get 100% financing which leaves them & the lender more at risk, because of no equity position. My take on this is with the rapid appreciation of real estate values as of late, both parties would be protected. Poor judgement on the lending institutions on that call, since Real Estate values increase and decrease over time.





Let me give you another example, some lenders used a 2/28 ARM product so these borrowers can build up their credit over time. So if the initial 24 month rate is 8% and it adjusts on the 25th. payment to 10% look at the math based on a $100,000. loan on a 30 year payout. For this example I used a principle & interest payment only. At 8% the payment is $733.76 at the adjustment rate of 10% the payment increases to $877.57. The monthly increase is $143.81. You can see where I am going with this. This would put the monthly budget in a tailspin. Most of the candidates for this type of a mortgage live from paycheck to paycheck. A lender may just issue a interest only loan with negative amortization, in which principle is added to the end of the loan.






Another interesting element in many subprime loans are the pre-payment penalty for the borrower. This one amazed me, it is more often than not that a person would not have the ability to pay off the loan ahead of time or pay additional principle payments on the loan. But if they could they would be penalized for doing so. In theory the subprime market has merit. Under certain circumstances the borrower must be fully informed in what they are committing to. A large number of these candidates are long time renters, and fail to realize that they, NOT the landlord are responsible for all utilities, insurance, taxes and repairs of their home. The savings rate in the United States is at an all time low. This falls the hardest in the subprime arena. To give you an idea how large the subprime market is; in 2006 it accounted for $600 Billion which makes up 20% of the $3 Trillion mortgage market. (source CNN Money)






In closing lenders will tighten their standards and they should. The high risk borrower will be removed from the market. The credit score requirements will increase with better creditor documentation, increase on down payment requirements, and more liquid assets in reserves. I see more foreclosures on the horizon. Since 2006 the arms will not adjust until 2008 and all bets are off. I tell prospects with a low credit score to continue to rent, try to pay down debt. Do not take on any more bad debt, and to build up their savings account or start one. This way they can get into main stream financing and secure a brighter future. If you have any questions feel free to email me: findit@LehighValleyRealty.com Have a great day.