Sub-prime is not the problem -- who is?

Posted: Mar 14, 2007 11:45 PM

I watch, read and listen to the pundits who have unofficially announced that the sub-prime mortgage market is dead or at least D.O.A. and I wonder if they have anything better to do during the day then make ridiculous statements. Is there trouble in the sub-prime industry?

Absolutely! Should you paint all of the tens of hundreds of sub prime lenders with the same brush? No! Are any of the lenders vibrant? Yes! Have there been changes made in the industry in the last two weeks? Of course. Now for my take on the entire affair. It might not be as everyone sees it, but it will be a lot closer to reality than what you have been hearing or reading.

The sub-prime lenders are those who lend to people with credit scores in the very low 600 range down to 500. They are also the lenders who lend to people with a good credit score and unusual circumstances as non conforming properties, borrowers without reserves, borrowers who have a spouse with good earnings and bad credit and one with good credit and marginal earnings, etc. Sub-prime lenders have been the "common sense" lenders for the past decade who have rules but can bend them for the right circumstances. That isn't what got them into trouble. What the problem was and will always be the same problem that is in many businesses--GREED!!

Taking chances to make more money, where I wouldn't do it or you might not do it either.

Our major sub-prime lender came out with 100% financing years ago which seemed to make sense. What didn't make sense was 100% to $1 million with a 580 credit score.

My first comment to my rep from that lender was "not with my money!" In my opinion, it was just too big of a risk! That is over. A week ago they dropped the 80/20 (1st and 2nd)followed by the one loan of 100% two days later . Now they won't do any loan with a loan to value or combined loan to value over 90%. They also will not go below a credit score of 540. The reason is no one else will do those loans and they were getting nothing but those types of loans being submitted to them. They didn't want the exposure so they shut it down. Will those loans ever come back ? Bet on it!

The one loan that sunk most of those going out of business now was "the liar's loan". It was a stated wage earner with a low credit score. Stated loans were developed for people who are self employed who cannot always demonstrate their earnings, primarily because they write everything they can off against their earnings. They, for the most part, are credit worthy and they needed a way to qualify so the industry developed stated loans. But why in the world did we need a stated wage earner loan? They do not have any problem identifying their earnings. They have W-2's, year to date pay stubs and we could always get a Verification Of Employment from their employer which tells everything about their earning's history with the company. Why did the sub-prime lenders develop this loan? It was an untapped market with a lot of profit because of the higher rates they could charge.

An important note about sub-prime loans that you need to know when you are reading and listening to the folks who are telling you the industry is collapsing : Sub-prime borrowers are generally late on their payments. One C.E.O. of a major sub-prime lender told me years ago that they rely on the lateness when making their earnings projections. At that time they were making $250,000 a month in late fees but he assured me that these borrowers had approximately the same percentage of borrowers who ended up in foreclosure as prime "A" borrowers.

The appetite to own property from those who are less credit worthy hasn't abated. The appetite to make these loans hasn't either. The industry will continue but changes will be made and in years to come I believe we will be close to where we were with programs, loans to value and credit scores.

I could go on with facts, figures and stories about sub-prime which is an area my Company has worked in for the last decade producing about 3/4 of a billion dollars of these loans. We have accomplished some extraordinary results including the one I am about to relay to you. For the past six months a gentleman has been trying to refinance his house which he is buying from his wife, with her blessing, because they are divorcing. For six months we have tried to get her to sign the deed and for one reason or another she wouldn't do it. When we started his new loan was in the six percent range and his credit score was about 620. Two weeks ago the deal was finally consummated but because she didn't pay the credit cards assigned to her, his credit dropped to 500 (one more point and the deal was dead).

His rate jumped to the high 8% range and the loan closed this week. If she had waited one more week the loan couldn't have been made because his credit score is now too low.

I hope this gives you another view of the sub-prime market which certainly had it's problems, but nothing compared to what might be the iceberg that sinks home lending or at least curtails an industry that is most vital to the economies health. It is the Option Arm which allows you to pay less than interest due each month and let the difference accrue to your balance. Instead of your balance going down it goes up and when it reaches a predetermined percentage (110% or 120% of the original loan amount) you then must pay both principal and interest. Your payment could double or triple, your equity is gone and your option then is foreclosure or deeding the property back to the lender.

I have talked negatively about this loan for years and now one of the nations largest lenders has a reported 5% delinquency rate on their portfolio. If real estate prices fall, which we really haven't experienced to a major extent, the aforementioned delinquencies could double and the economy could be in serious trouble.

I hear nothing about curtailing this type of loan from any of the lenders who specialize in these. While Rome burns, the prime lending institute is still selling matches! Why?

I will give you a hint. The word begins with a G.