OfflineThis is an article I found on cnnmoney.com that talks about the return of subprime loans. They sill cater to people with loan credit scores but they are expensive loans. One difference between the subprime loans that are starting to be offered to people with lower credit scores is there are no ajustable rate loans being offered.
Borrowers with bad credit were shut out of the mortgage market after the housing bubble burst, but now a handful of small lenders are starting to offer subprime loans again.
Once synonymous with toxic, adjustable-rate mortgages -- like the "exploding ARMs" that led many homeowners to lose their homes to foreclosure during the housing bust -- subprime mortgages are once again being offered to borrowers who pose a higher credit risk, typically those with credit scores that fall below 640.
But this time around, the loans are much more costly. During the housing bubble, lenders were handing out subprime loans with cheap teaser rates and little or no down payments. Now, lenders are charging interest rates of as high as 8% to 10% and requiring borrowers to make down payments of as much as 25%-35%.
The premium price is worth it for some borrowers who are trying to build or repair their credit, according to Bill Dallas from Skyline Financial, of Calabasas, Calif. Skyline started offering subprime loans a few months ago under its NewLeaf Lending division.
Among his firm's subprime mortgage customers: young, first-time homebuyers and former homeowners whose credit was ruined in the housing bust.
"They're just Americans who want to buy homes but can't," said Dallas, who used to run First Franklin, a subprime lender that went bust in the mortgage meltdown.
Most of these borrowers have nowhere else to turn. Fannie Mae and Freddie Mac, which back 80% of all U.S. home loans, won't back loans issued to subprime borrowers.
Only the Federal Housing Administration continues to support low-credit score borrowers in the wake of the housing bust. But it has hiked fees and premiums.
To help protect borrowers, the Consumer Financial Protection Bureau requires strong consumer protections. The loans cannot carry interest rates that increase after default, or prepayment penalties, for example. And lenders must provide these borrowers with homeownership counseling from a representative approved by the U.S. Department of Housing and Urban Development.
In addition to the small lenders who are issuing subprime loans, Wells Fargo recently lowered the minimum credit score it requires of borrowers to get FHA loans.
Wells Fargo is now approving applicants who have scores of between 600 and 640 for FHA loans, which remains well within FHA's guidelines, according to spokesman Tom Goyda.
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An old saying says: "There is nothing new under the sun." To think that subprime loans would not come back would be illogical--they fill a need. There is a category of people with damaged credit who are not content to be renters for the rest of their lives, and need either sub-prime loans or some version of seller finance to support them.
We have learned from the extreme loose standards of the early 2000's, that there need to be more controls. These controls came in the form of the Dodd Frank Act to protect consumers in getting consumer loans. Regardless of my personal attitudes about the way this Act is set up and enforced, we are going to see its impact on both lender finance and seller finance with properties. The mention above about no more adjustable rates should also have indicated that there will be no balloon payments either. This is the legacy of Dodd Frank.
We as investors should realize that offering seller finance to consumers/owner-occupants has some dangerous components these days, and the only type of agreement that seems to offer some opportunity moving forward is lease option, and that must be done carefully (see my posts on Dodd Frank and Lease Option).
There is still a huge opportunity to assist people with less than perfect credit through a lease option, but you will need to qualify them more carefully to a 43% DTI ratio or lower, check their income and employment, etc. Expect that sub-prime loans will be checking these things very carefully also, and that there will be tight controls on adjustable rates and balloon payments in any loans that hit the market, prime, sub-prime, or otherwise.
Dallin Wall
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