I was contacted yesterday by Stephen Gandel a Senior Writer from CNN’s Money Magazine. Stephen wanted to know if there were still “exotic” mortgage products available. I told him about a recent approved application where the borrower has no income, no job, and the property that secures the loan is listed for sale. What we agreed on is that some of the best lender situations appear risky on the surface, but when the entire “loan snapshot” is reviewed, that same “risky” situation is on occassion found to be very safe and well secured. (See the article at CNN.com: Risky loans - alive and well)
The cause for investors concern is high foreclosures nationally. Rising foreclosures cause lenders to stiffen their credit requirements.
You see, “exotic” is exactly what subprime lending is all about. Subprime is non-traditional lending. It’s sort of a risk/reward situation.
Subprime lending is good for:
- borrowers with zero down payment
- borrowers who have to utilize a relative for credit score
- borrowers with good credit but zero down and no proof of income requirement
- borrowers who have had serious credit issues but have somewhat re-established
A brief history in subprime lending
Let me regress a few years and see if we can put together what caused this whole situation in the first place; and, more importantly how it will effect todays prospective buyer/borrower.
Dateline: July 2003 - interest rates hit 25 year lows, and everyone and his brother are refinancing in order to secure themselves the proverbial 30 year fixed rate mortgage at 5.25%.
Not everyone is enjoying the boom, the sector of the market that is not as busy are the subprime lenders.
Subprime lending is a way to offer flexible mortgage products to clients who fail to meet “conforming” loan criteria. Some borrowers have credit issues, other borrowers have income issues, while still other borrowers have “down payment” issues.
In conforming lending, when a prospective borrower does not meet a particular guideline, the loan is usually declined. In subprime lending guidelines are less rigid. Boundaries can be adjusted. In conforming lending some guidelines just cannot be adjusted.
So back to dateline July, 2003…The market is inundated with easy to approve high credit grade “conforming” applicants and those applicants are desperate to lock in their super low interest rate. These high credit score borrowers want to get in while the rates remain low. Loan officers are overwhelmed with “conforming” mortgage applications.
Due to the volume of applications loan officers are ignoring “subprime” applications because of the easy underwriting and fast approvals of their “conforming” applicants.
Subprime lenders scramble to creative “inovative” products and begin to relax their requirements. By doing so, they capture the attention of the banks and brokers thereby creating opportunities for borrowers who otherwise would not have qualified for products such as zero down payment options, and loans with no income verification.
Subprime loans become the “golden child”
As interest rates climb, banks and brokers begin to see these subprime programs as much more attractive alternatives.
The same time that credit and income requirements are eased, property values begin to dramatically increase.
This already precarious territory has a new exotic product to entice back some conforming clients…enter the: 1-Month Option Arm a redhot mortgage product that allows borrowers and buyers the program to fulfill a purchase for lowest of the low payments.
Property values soaring, exotic product offerings…next thing you know, we may have a runaway market. (Greed is the motivating factor in upruns).
What goes up must come down
During a frenzied market, the mindset becomes: “purchase a property and double your money”. But the fact is, everyone won’t get rich. Some buyers forgot to remember: “what goes up; must come down”. Tough lesson…but what’s the moral to the story?
I learned a lesson as a young bodysurfer growing up on the beaches of Encinitas, California. The lesson is this: “big waves get small; and, small waves get big”.
Can a person still get a quality mortgage loan…absolutely. Are the credit requirements as lenient? No.
Are the banks taking a wait and see approach? Yes.
Are there still exotic products in the market place? Yes.
Can I still buy a home with zero down payment? Yes, but your credit needs to be better than it needed to be 3 months ago.
“Are people still getting Option Arm Mortgages?” Yes!! Yes!!...I got one myself…why shouldn’t you?
Banks don’t stay in business unless they loan money.