The Subprime Fallout (and What We Can Do About It)
By Ed Fallon, Carteret Mortgage Corporation

The barrage of bad news about the subprime mortgages affects us all. Some of the largest subprime (or weak credit) lenders have closed their doors, stung by buyback requests from investors and loss of confidence by the banks supplying their warehouse lines of credit. (Mortgage lenders depend on warehouse lenders for funding loans before selling their loans to the secondary market.) The remaining lenders have tightened their guidelines in an attempt to improve loan quality. The rising tide of delinquencies and foreclosures has sparked hearings on Capital Hill and calls for increased oversight and regulations of lenders and loan officers.

But subprime loans are for people with bad credit, so how does that affect everyone else? It impacts us all in several significant ways. First, increasingly tightened guidelines will result in more buyers that won’t qualify to buy a home, and others will pay a higher price in the form of higher interest rates. Subprime mortgages made up 21% of mortgages made in 2006. Fewer buyers mean lower demand for homes, which could impact sales and prices. Second, foreclosures and delinquencies have a damaging effect on home values in the immediate surrounding neighborhood. Subprime loans that were delinquent by 2 months or more were 12.44% in February, more than five times the rate of all mortgages, and foreclosures are rising as well. Third, there is the very real danger that overreaction by lawmakers could also stem financing for Alt-A and prime borrowers. Alt-A (with credit between prime and subprime) and prime credit loans have also seen increased delinquencies and foreclosures, though nowhere near the level of subprime.

Politicians and the media have placed the blame squarely on lenders, blaming too lax guidelines and illogical loan combinations (100% financing, interest only, no doc loans to someone with bad credit, for example) as the problem. No doubt that has contributed to the problem. Some lenders have been too aggressive in lending to borrowers who are a poor risk. But there is also much evidence that points to two other culprits. First, those areas hit hardest with job losses are the ones experiencing the highest delinquencies. Second, many subprime borrowers who refinanced again and again to bail themselves out of trouble in the early part of this decade have been unable to do so in the last year as appreciation has slowed, and some areas of the country have experienced depreciation. Job losses and lack of equity will have a bigger impact on delinquencies than aggressive underwriting guidelines.

That’s the bad news. It is also important to note that while some may criticize many of the new loan options as irresponsible and reckless, others see it as innovative, and as a way to open homeownership up to more people that would have otherwise been excluded. Homeownership is a right, and we are obligated to find ways to help willing, motivated and qualified buyers achieve that right. If we make 100 loans to subprime credit borrowers, and 10 fail, we can’t just focus on those 10. We also need to remember that we have 90 families that we have put into a home that otherwise may not have qualified. And with that, learn a lesson from what went wrong and try to improve.

There is more good news, actions we can take to help buyers, sellers and homeowners increase their affordability. Planning is the key. The first would be to identify and address problems as early on in the home buying process as possible. Don’t discard buyers with bad credit. Working with a knowledgeable loan officer and a legitimate credit repair company, you can dramatically raise a buyer’s credit score by addressing those factors that impact credit scores the most. This will usually take a few months, and requires commitment and discipline on the part of the buyer, but it will more than pay for itself in lowered rates and increased buying power. Even 1 point on their credit score can mean the difference between a subprime and prime mortgage, and a difference in interest rates of 2 to 3%. Second, sellers are affected by this too. A seller in trouble with their mortgage can be a motivated seller. Better to use a reputable real estate agent and lender to help them solve their problem now rather than to wait and end up in foreclosure. Third, those prospects not ready to sell now may benefit from a mortgage and equity review. Let a reputable lender show your future prospect a way to better manage their debts and their equity.