Lenders make it tougher for those with bad credit
Subprime borrowers will still
find some willing lenders, but expect rates to rise.
Holden Lewis Bankrate.Com
March 18, 2007
Mortgage lenders are tightening standards for loans to the 15 percent of potential borrowers who have the worst credit.
Even with these more rigorous standards, many credit-impaired borrowers can find willing lenders -- albeit at higher rates than were being quoted as recently as early February.
"I think for the vast majority of people, they don't need to worry about it," says Jim Sahnger, a mortgage consultant with Palm Beach Financial Network in Stuart.
But a few have reason to worry. They include homeowners with poor credit histories who want to refinance but who have less than 10 percent equity in their houses. Those with poor or fair credit who don't want to verify their incomes or assets, are also finding it more difficult to qualify for loans. Especially if they want to borrow more than 95 percent of a home's value.
These stricter lending standards are the fallout from the meltdown in the subprime mortgage market. About 15 percent of mortgage borrowers are in the subprime category. These are the least-creditworthy borrowers, with credit scores less than 620 (on a scale of 300 to 850). About 85 percent of mortgage borrowers have credit scores of 620 or higher.
So far, most prime customers needn't worry about being turned down for home loans on the basis of their riskiness as borrowers, so long as they're willing to let the lender verify their incomes and assets.
Stricter standards come in the form of higher minimum credit scores, lower maximum loan amounts and requirements for bigger down payments. In many cases, lenders raise the minimum credit score by 20 points or even 40 points to qualify for a type of loan.
But that's not much of a deterrent to mortgage brokers, who originate most subprime loans, says Christopher Cruise, who trains mortgage brokers and loan officers. Brokers have multiple lenders to choose from, and if one lender makes a certain loan program unavailable, a broker probably can find another lender who still offers it.
Lenders haven't only tightened standards. They have boosted rates. Rates on the most popular type of subprime loan, called a 2/28 mortgage, have gone up about 1.5 percentage points to 2 percentage points since mid-January, says Jim Svinth, chief economist for LendingTree.com. That rise is purely a reflection of credit risk.
A 2/28 mortgage has an initial interest rate that remains fixed for the first two years. Then the rate adjusts annually after that. The fully indexed rate -- the rate after two years -- is high on this type of loan, often above 10 percent. These loans are intended to be temporary; the borrower is supposed to make on-time payments for two or three years and then refinance to a lower-rate prime mortgage. There's often a prepayment penalty that shackles the borrower to the loan for two years.
For at least a year, analysts have warned that the loose lending standards of the past few years would result in a spike in foreclosures. That's starting to happen among subprime borrowers.
Brokers can't believe how lax the subprime lending requirements were just a short time ago. Investors were eager to buy mortgages, especially high-rate, risky home loans with prepayment penalties, because they were profitable. So investors pushed loan officers and mortgage brokers to find borrowers with lousy credit. Brokers and loan officers were paid handsomely for delivering subprime borrowers.
"I think it's worried a lot of people in the mortgage business," Cruise says. He says his students sometimes wonder aloud why the loans they are originating are legal.
"So long as these loans are legal, we'll continue to sell them," Cruise says.
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