The sub-prime mortgage market is seeing some tough times. Several heads of sub-prime mortgage companies have been summoned to appear before Congress. Freddie Mac is stepping in to help borrowers who are in bad loan situations. Fannie Mae is calling upon mortgage lenders to reduce rates and monthly payments for the thousands of borrowers nationwide with mortgages they can’t afford. While only 20% of all sub-prime loans are estimated to actually default to the point of foreclosure, everyone is pointing fingers at the sub-prime lending industry for today’s sluggish real estate market.
Why were so many people sucked into sub-prime loans? For people with less-than-perfect credit, sub-prime loans were a godsend. The original concept behind sub-prime loans was a good one—if you have troubled credit, you can get a sub-prime loan now, improve your credit, and refinance into a prime loan (at a lower rate) when your rate adjusts. The reason that sub-prime lenders were able to extend loans to borrowers with lower credit scores (typically FICO scores between 540 and 680) was that they were more willing to assume higher risk of default. To mitigate the risk factor and protect themselves, sub-prime lenders charged higher rates, depending on the borrower’s credit profile.
As the sub-prime market started to really pick up speed between 2003 and 2005, more competition for the same pool of borrowers caused sub-prime lenders to increase their risk-tolerance thresholds and make imprudent lending decisions. Loans offering more than 100% loan-to-value ratios, debt-to-income ratios above 50%, and loans that required no income or asset verification grew in popularity, attracting more borrowers who otherwise would not have qualified for a loan. Sub-prime mortgage brokers and real estate professionals with sales quotas added to the frenzy, matching borrowers up with loans that helped on the short term but ultimately eroded their financial health.
The difference between a sub-prime lender and a prime lender isn’t just in the rates they charge or the types of mortgage options they offer. It has to do with risk. While sub-prime lenders measure risk in terms of their own bottom line, prime lenders measure risk with the borrower in mind. Prime lenders look at the whole picture—while they want to help get borrowers into a loan they can afford on the short-term (offering one-year to five-year adjustable-rate mortgages that keep the rate low initially), they also look for ways to make sure that the borrower can stay in the loan or can easily refinance when their loans adjust (offering no-prepayment-penalty options, expedited refinancing options for existing borrowers, etc.).
And if a borrower doesn’t qualify for a prime loan, responsible prime lenders will help that borrower to understand why they didn’t qualify and what they can do to improve their chances for a loan (improve their credit score, reduce their debt-to-income ratio by paying off debt, increase or reduce their number of tradelines, seek out a more affordable home to buy, etc.).
During the height of the sub-prime boom, many credit unions and smaller lenders were pressured to start underwriting sub-prime loans—and many jumped on the bandwagon. Without the risk management infrastructure that most large sub-prime companies could afford, smaller financial institutions are now finding themselves in hot water with low demand for new loans and high default rates on loans in their portfolios.
Even though there was significant demand from the market, Technology Credit Union did not originate sub-prime loans. By holding true to our prime strategy, Technology Credit Union was not only able to avoid the sub-prime backlash, but was also able to increase our portfolio to over $1 billion in loans in 2006. While Tech CU does not originate sub-prime loans, Tech CU does offer opportunities for borrowers who may have faced financial hardship in the past. As a credit union, Tech CU looks out for what’s best for the member—including educating members about how to improve their financial situation and offering loans to them once they’ve got their credit on track.
For more information about Tech CU’s lending programs, please contact a Tech CU mortgage consultant.
http://www.techcu.com/learning/home_buying/SubPrime.htm
