Let's stop the problems: Get rid of sub-prime loans

Posted: Jul 24, 2007 2:05 PM

Even if it would help, which it wouldn't, I certainly would not advocate getting rid of sub-prime mortgage loans. Yes, I do a great deal of business in sub-prime loans but in ways that most people wouldn't imagine. Yes, I even pay more to my loan officers for these loans because I can. And yes I am very bullish on sub-prime loans because they do things for borrowers that conventional lenders wouldn't consider (in my opinion for no reason). Let me explain and maybe you will understand the need for this segment in the mortgage industry.

I became interested in sub-prime loans in 1994 right after we had a major earthquake in Southern California and Alan Greenspan started raising interest rates. The mortgage industry went into an immediate shock mode and didn't come out of it for about 15 months.

I was determined to find an aspect of our industry that wouldn't be as susceptible to interest rate swings as the general market and it turned out to be the sub-prime sector that fit the bill. Sub-prime means less than a prime borrower and one who cannot be rate conscious because of the limited amount of lenders supplying these types of loans. (This group has grown significantly since the early 1990's).

Sub-prime has the last of the common sense lenders. They are concerned about their collateral as much as prime lenders, even more, so they concentrate more on the appraised value than "A" lenders. They are less interested in the past earnings and more interested in the cash flow of the borrowers. They are always looking for compensating factors to offset bad credit such as length of time in the property, time on the job, years in the profession and elapsed time since the borrower had been late on the mortgage payment . They do have higher rates to compensate for the credit problems but they don't have many surcharges such as paying extra for cash out or higher loan amounts.

They give everyone in this Country another chance, or another chance after the first chance and even another chance after that. If borrowers appreciate the opportunity afforded sub-prime lenders then they try to clean up all of their credit and take some cash out for reserves as well. They make sure they don't go right back to credit cards, they pay their mortgage payments on time and in a few short years they gracefully bid adieu to the industry and become prime borrowers. That is the highest and best use of the sub-prime industry.

But I started by telling you that I use sub-prime lenders in a way you don't imagine. I use them to give my prime borrowers the best rates and terms I can give them from all the choices they have in the sub-prime and prime areas of the industry. In the middle of the 1990's I began noticing sub-prime lenders pricing their loans by a combination of the loan to value and the credit score. Using the charts at times they had the best rates for arms and fixed loans for loans at 65% loan to value or less and a 680 credit score or more. This usually happened when rates in the prime market started to go up and the sub-prime lenders, who never reacted to the day to day gyrations of the interest rate market, would wait a few weeks until a new trend was set. This was an opportunity. In the late 1990's the opportunity presented itself and I moved on it. A 30 year fixed was available under the parameters mentioned above for primary or second homes for jumbos up to $1 million in the middle 6% range without points. The loan had a 3 year prepayment penalty but no one cared as this was a 30 year low for this fixed loan.

Although I made 30 or so clients very happy within a couple of years every loan paid off, including the penalty, because we hit 40 year lows which were as much as a point lower.

Both the borrowers and the lenders were happy and I continue that approach whenever it is available.

On the other hand, our sub-prime lenders offer programs that prime lenders for the most part don't. They will allow a couple to swap credit scores up to 100 points higher if the one with the best score makes at least 30% of the family income. They will allow borrowers to qualify with their bank statements, using the deposits not the balances, to measure their earnings through the cash flow. They will allow renters to buy their rental and get the equity that is above the purchase price as their down payment. They will allow cash out above paying off bills, as the later isn't considered cash out. Unfortunately they aren't giving people a break on stated income because of the mis"stated" income that caused the current debacle. They will do a partial stated, partial full doc loan with a low enough loan to value to feel comfortable enough to fund the loan.

The sub-prime industry is not today's villain. They really are the good guys who try very hard to make it right for those who need their help. They are being blamed for everything from Option Arms which was a savings and loan invention to charging too much which is entirely a Wall Street decision. The loans have to be sold and Wall Street dictates the rates and terms. When the industry lowers their rates Wall Street goads them back up. And then comes the greedy ones who promote the nonsense and every one gets a black eye.

Sub-prime lenders do know how to underwrite loans but aren't immune to fraud and lying that has increased dramatically over the years. Take that out of the equation and we probably wouldn't have the debacle we are currently going through. Take the leverage out of the sub-prime mortgage pools that were sold to investors on Wall Street and we might not be talking about the industry at all.

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