Subprime Loans are Back
Since the housing crisis began over a decade ago, subprime mortgage loans basically disappeared – thanks to regulatory actions from government and self-preservation for both lenders and borrowers. The effects of borrowing more than you could safely afford to repay became obvious to all parties.
Subprime mortgage loans have been making a slow comeback over the last decade, driven by years of pent-up consumer demand and lending institutions competing for more business.
If you have borderline or poor credit (credit scores in the 580-669 range or below), lenders are devising new ways to offer you a mortgage loan. Are you ready to take advantage of these offers – and, even if you are, is a subprime loan the best choice for you?
Increased Risk But Greater Scrutiny
Data from the Mortgage Bankers Association (MBA) shows that during the first quarter of 2007, approximately 13% of all residential mortgage loans were subprime loans – totaling almost $115 billion, according to the Federal Reserve. By the end of 2017, the subprime loan volume decreased more than fivefold to $20.4 billion.
There's still a market for subprime loans, but the rules are different from the pre-crisis days, when about all you needed to qualify for some loans was a pulse. It's important to keep context when assessing today's situation.
Banks are now held to a set of risk-defining rules for Qualified Mortgages (mortgages that may be sold to Fannie Mae) and the Ability-To-Repay rules that require lenders to reasonably assess the ability of a borrower to repay the loan. Ability-To-Repay factors include debt-to-income (DTI) ratio, ongoing expenses, other debts, employment status, income – and credit history. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.
A poor credit score doesn't necessarily disqualify you, but it does increase your risk – making it more likely that you will be serviced by a non-bank lender. Non-bank lenders don't have the same restrictions for Qualified Mortgages, but they must still follow the Ability-To-Repay rules.
Banks are indirectly re-entering the subprime market by making loans to non-bank lenders – therefore, participating while staying one step removed from the risk. A Wall Street Journal analysis uncovered $345 billion in loans between 2010 and 2017 from large banks such as Citigroup and Wells Fargo to the non-bank market.
In short, money is available, and you can get a loan with subprime credit – but there are still risks and economic tradeoffs involved. You must research those carefully before you apply.
New Name, Same Product – Mostly
Lenders can't hand out money as in the freewheeling days before the housing crisis. Today's subprime loans, generally rebranded as "non-prime loans" or something similar, carry more requirements for borrowers to meet. Even so, these loans include ways to mitigate the risk to lenders – as they should. You have a subprime credit score for a reason.
Higher interest rates are likely, as are higher down payments. Subprime loans are more likely to be variable rate loans with a short, fixed-rate period (two to five years) followed by a rate change based on current interest rates plus a margin.
Interest rates may be rising, but they are still not far from historic lows – so a variable rate loan is a big gamble on interest rates remaining low (or in your ability to improve your situation and refinance before rates rise.)
Homebuyers with subprime credit must shop around for lenders and carefully compare terms. Use online calculators to run different scenarios. Try a best-case, worst case, and most likely case – then throw out the best-case option. Those lead to bad decisions.
Limit your risk by being realistic about the size/price of home that you can afford. You may qualify for a $200,000 loan, but is that what you need? Could you choose a less expensive home, increase your down payment, and make your monthly mortgage payments more manageable?
By doing so, you can keep your budget under control and improve your credit score with on-time mortgage payments – perhaps allowing you to refinance at a prime rate in the future. MoneyTips is happy to help you get free mortgage and refinance quotes from top lenders.
The Takeaway
Subprime loans may be reappearing under a new name and a tighter set of rules, but that doesn't change basic risk assessment. Are your finances strong enough to take on the added risk of a mortgage debt, especially when that debt comes at a higher interest rate?
The answer may be yes. You may be just starting out with a good-paying job and have a low credit score because of a limited credit history. Perhaps you are on the rebound from past problems and your credit score is rising along with your income and assets. However, the real answer may be no. Be honest with your self-assessment. If you can't do that, have an independent financial professional do it for you.
Banks and non-bank lenders act like any other business. They are driven by profit and serving/expanding their customer base while staying within their regulatory constraints. In turn, you may be stretching to buy a home out of desire to upgrade your housing or frustration at the slow recovery.
Both parties have incentive to stretch financial boundaries – but you must be the one to correctly assess your financial breaking point. If you decide to enter the housing market with poor credit, shop around for your loan options, and understand your limits before you decide.
Photo ©iStockphoto.com/BrianAJackson
