Subprime Mortgages are back, but with under a different name!

**DISCLAIMER** I am not a lender, and by no means a financing expert. This is just my $.02 that I wrote for a real-estate finance class in college.

Subprime Mortgages are back, as Non-prime Mortgages

The Subprime mortgage has recently made a return. This is crucial to understand in order to avoid falling into the same pitfalls that we did in 2006, 2007, and early 2008. I am inherently a little reluctant to trust that the subprime mortgage will be any safer now than it was last decade, but perhaps it will be implemented in a way that protects the borrower a little more? Let’s see!

An article by CNBC quoted the California-based Carrington Mortgage Service as saying: "We believe there is actually a market today in the secondary market for people who want to buy non-prime loans that have been properly underwritten," said Rick Sharga, executive vice president of Carrington Mortgage Holdings. "We're not going back to the bad old days of ninja lending, when people with no jobs, no income, and no assets were getting loans. (Olick, 2018)" Okay, at least they acknowledge how dangerous the original methodology of “underwriting” people for subprime mortgages was.

Potentially Dangerous lending criteria

It appears these loans are going by the name of “Non-prime Mortgage” now, which just sounds like legalese designed to find loopholes in the regulations on Subprime mortgages. These non-prime mortgages have relaxed lending standards that allow for people with credit scores as low as 560 (one website stated 500) to potentially qualify. They also increased the debt to income DTI from 45% to 50% citing the justification that millennial's often carry more debt (student loans plays a large role here) and that was hindering there ability to purchase real estate.

Lenders have stated that they require a 20% down payment to qualify for a non-prime mortgage (some companies require 30%). That could theoretically mean these mortgages are targeted toward the self-employed individual who does not have a W-2 but makes a healthy income. The problem is this could also apply to the kid that just inherited a decent amount of money, and has low credit because they are terrible with their finances. “One of the biggest differences of non-prime loans is their length: 40 to 50 years at fixed rates that leads to paying more interest, compared to conventional 30-year fixed mortgages, Kadimyan says. If a “teaser rate” is offered — such as on an adjustable rate mortgage — it could only last a few years and then adjust according to the index it’s tied to. (Crowe, 2018)” Can you imagine getting locked into an adjustable rate mortgage that could theoretically last longer than you live? That sounds insane to me. Obviously, you can refinance out of this loan, sell the property, or pay it off faster, but I don’t think most will do this. I fear that young people will look at the lower payment due to the long term and purchase a bigger house, rather than save the difference. This theory seems justified because of what I have witnessed people do with the new 7-8-year financing options for vehicles. This article goes on to state that someone with a 580-credit score might start with a 7 percent interest rate and then after a few years it could slowly begin to climb.

According to the Foundation for Economic Education “‘verifying employment’ is a term used rather loosely. In order to get approved for a $1.5 million loan, all these non-prime lenders really need to see is a bank statement to show that you have some money in the bank. And when it comes to credit scores, even those with FICO scores under 500 qualify. Additionally, past foreclosures, bankruptcy, and a history of late or missed payments will not decrease your chances of approval. (Hunter, 2018)” Let me reiterate that, past foreclosures, bankruptcy, and a history of late payments will not decrease your chances of approval!

It is still very early in the game for these non-prime mortgages, but apparently around 90% of the people who apply for them are approved. These loans are up to 1.5 Million Dollars, and as we have discussed previously they come with some risky payback plans. Keep in mind that 90% approval rate is on a group of people that generally do not qualify for traditionally (safely) underwritten mortgage loans. This sounds entirely too familiar to what I have read happened in 2008.

Conclusion

I don’t believe we have changed as much as we would like to think we have. Bringing back non-prime mortgages is a dangerous way to approve home buyers that probably shouldn’t be approved to buy homes that they probably can’t afford. We are going to open the floodgates to people with low credit scores and a history of late payments, bankruptcy, and/or foreclosure…I fear that this can’t end well.

David Pere

References

Olick, D. (2018, 04 12). Subprime mortgages make a comeback-with a new name and soaring demand. Retrieved from CNBC: https://www.cnbc.com/2018/04/12/sub-prime-mortgage...

Crowe, A. (2018, 05 14). Subprime mortgages are back - with a new name. Retrieved from Mortgageloan: https://www.cnbc.com/2018/04/12/sub-prime-mortgage...

Hunter, B. (2018, 10 18). Subprime Loans Are Back, Proving We Have Learned Nothing from 2008. Retrieved from Foundation for Economic Education: https://fee.org/articles/subprime-loans-are-back-p...