Why We Need Sub Prime Loans to Return

Posted: Jun 25, 2013 12:01 AM

Sub Prime loans are not a problem for the financial community they are a solution. If you spend an hour on my end of the phone you would realize the need for these types of loans. The number one question is "why can't I get a loan if I have never missed a payment on my current loan and the new loan will have a lower interest rate and lower payments?"  Certainly not an easy question to give an intelligent answer.

Most people are sure that the entire financial crisis in this country was caused by subprime loans who supplied ""liar's loans"": stated income loans for wage earners.  I never agreed with this even when the practice was used for prime loans.

Subprime loans were less than 10% of all mortgage loans, and the liar loans were probably around 1 to 2% of all mortgage loans.  Neither the subprime, nor the subprime liar loans caused the financial crisis of 2008-present.  What they did do is allow people without traditional sources of income, or great credit or large reserves a chance to get a property and work their way out of their deficiencies.  

What they offered were loans that used their bank deposits for a year or two to be the earnings of the borrower.  This means they used the cash flow of the borrower, averaged over a period of time to determine what they could afford.  Cash flow makes sense and it worked in subprime.  Obviously those deposits well over the average had to be sourced and proven they were earnings.

Rates were higher, but ratios were expanded a bit, Credit scores were lower. The most popular loan was a 2 year arm, fixed for 2 years and amortized over 30 or 40 years.  The 2 year arm gave people a chance to clean up their problems and become prime borrowers again.

Our approach to subprime was to get the borrower enough money out to refinance their mortgage and pay off their other obligations.  We didn't stop there because if we did the majority of borrowers would run up their credit cards again.  We also gave the enough cash to build a reserve so they wouldn't return to the credit card cycle.  For the most part we were extremely successful and the borrowers went back to prime mortgages.

Now imagine if you will an automotive industry without repair shops, tune up shops, collision shops and any other place where a new car can be helped back to its former glory.  Subprime is the repair shop of the mortgage industry.  What it offered was a second chance for those who had stumbled; those who used it properly usually became successful homeowners. Real estate could really use subprime loans at this time to offer a chance to a greater number of people.

For those who are against subprime loans read on and see if you really understand them. If you are sure you are adept at picking out subprime loans I will list a few loans that I have originated and see if you can find the subprime ones.

1.  A negatively amortizing loan with an initial payment rate of 1% for 5 years and an interest rate of 1.5% over the 1 year Libor after the first six months of the loan.

2.  A $1 million 30 year fixed with full documentation @6.5% in June 2000

3.  A no documentation loan for 100% purchase of $1 million house.

4.  A $3.2 million refinance with $1.7 million cash out on a 5/1 arm.

5.  A 3% down purchase by a borrower who needed a co-signer to qualify.

Write me with your answers if you want and I will tell you if you’re right or wrong and why.