All About Subprime Mortgages

Do you know what you need to be aware of regarding subprime mortgages? As a lender, it is your responsibility to learn about the current mortgage trends as well as the different types of mortgages.

So what exactly is a subprime mortgage?

A subprime mortgage is a mortgage that is made available to people who have lower credit ratings. Due to their low credit ratings, these clients cannot be offered the conventional mortgage because they are considered to have a higher default rate on the loan. In addition, they are charged a higher interest rate compared to the conventional borrowers in order for the lender to compensate them as a result of harboring a higher risk load.

The subprime mortgage industry has been faced by a number of constrains which almost led to its foreclosure and financial meltdown a few years ago. The two major issues include high unemployment rate and drastic increase in defaults. However these were overcome through proper advice to borrowers and guiding them through available options.

Who qualifies for subprime mortgages?

A credit rating of below 600 points will only qualify one for a subprime mortgage. Two major factors that make a candidate qualify for this mortgage are a declaration of bankruptcy and filing a late bill payment. They would need time to raise their credit points to qualify for a conventional mortgage. Other than the credit ratings, a person may be deemed to fall into the class of subprime if they do not bear proof of their assets or income like they would do with a conventional home loan.

Subprime mortgages are usually balloon mortgages or they are ARMs, or even both. They are usually more pronounced during when the demand for housing is high because at that point they attract a lower interest rate in the initial 2-3 years. However, after this period the rates are reviewed upwards after semiannual or annual periods. Subprime mortgages loan also may involve a balloon payment and a prepayment charge.

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Condo Market is on the Rebound

New condo developments are being built all over the United States as the condo housing market booms for the first time since the housing crash. From L.A. to New York to Boston, condos are sprouting up at a fast rate. And according to developers and lenders, condos are selling. Soon, they will be selling like hotcakes.

So what’s the reason for the sudden boom in the condo market? After all, condominiums are notoriously known for being risky bets in real estate for developers. The condo boom is actually in the early stages of a long recovery process for condominium sales. Financial experts predict that today’s renters will soon be tomorrow’s condo buyers.

The current scramble to build developments is an attempt to keep up with the growing demand for condos. Some brokers claim that there is a big lack of inventory in the market so far.

Condos are highly sought after by young, first-time homebuyers and empty nesters that are looking to live in denser areas like Miami, Seattle, and San Francisco. A few years ago, high-end condominium sales began to rise when rich international buyers wanted to buy them. As the demand for condos goes up, smaller markets are now beginning to catch up.
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Mortgage Company Creates Marketing Niche as Lending Rules Tighten

 

There is hope for many borrowers who cannot quality for a typcial mortgage due to the new lending rules. WJ Bradley Mortgage Capital, a Colorado home loan originator, considers those who are left in the dust by the new rules to be the perfect opportunity.

According to an article on Reuters, WJ Bradley will welcome borrowers who have debt-to-income ratios and FICO scores that are outside levels required for typical agency home loans. They will begin lending around the US in the next month or so. WJ Bradley plans to offer one type of loan to begin with a 5/1 ARM, an adjustable-rate mortgage that has a five-year introductory fixed-rate period before it adjusts once a year thereafter.

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How to Get a Workaround for the Non-Qualified Mortgages

Many lenders are concerned about the advent of Qualified Mortgages (QM), with the federal government implementing standards and compliances for mortgage loans. The concerns are for the potential litigations rising in future due to, when and if, the borrowers default on payments. But there are industry experts discussing opportunities which exist beyond the barriers of QM. These opportunities are for lenders to make profits and deal with mortgages having extremely low liabilities.

Identify the borrowers with minimum risk potentials from the ‘unqualified’ mortgages

One of the data firms has mentioned in their reports that around 60% of mortgages will not qualify as QMs. Within this percentage of mortgages, there are loan programs which have the debt-to-income (DIT) ratio exceeding 43%; completely unacceptable under QM norms. The mindset – all DTIs surpassing 43% will be defective – with which the norm was drafted is wrong. In this list of defective DTIs, there are borrowers who have excellent credit history, have made 25% to 30% down payment for a house, can provide paperwork showing their assets and income, and can also prove their employment under professional occupations for a term of more than five to six years. With these kinds of borrowers the loans are incredibly safe; ideal for non-QM programs.

What should good non-QM programs carry?

A well-thought and well-structured non-QM program will always have credit standards which brilliantly handle the concept of compensation factors. The criteria should extensively lower the chances of payment defaults and any other triggers/factors making the borrowers opt for legal challenges. Also, the program should be encouraging buyers to go for at least a 20% down. The interest of the borrowers to make the down payment can be gauged from their credit scores. The higher the score, higher are the chances of borrowers willingly going for the expected downs. The programs can also benefit if they are developed focusing on certain occupations, such as government employees.

Keeping these ideas in mind, imagine what kind of programs the credit unions can work on if they tap into their vast and exclusive databases filled with customer information.

Amortization and ‘interest-only’

How about pitching programs with features like negative amortization and interest-only periods to high-income earning consumers? To financially decent borrowers, these kind of flexible programs are often quite appealing. Of course, risks with these programs are high. But one of the precautionary measures while marketing such programs is to avoid doing it on a big scale. The filtering and screening process for identifying the right type of clients needs extreme supervision, which falters if the numbers go drastically higher. 

This could very well affect the availability of mega (or jumbo) loans because they do not conform to the Fannie/Freddie loan limits. This means that they will not be deemed qualified if the debt/income ratio of the borrower exceeds 43%.

Every situation carries opportunities; sometimes its windows are smaller and sometimes bigger. Same goes with the advent of QM. While there are some fears, there is also some hope floating around. So give a thought to these workarounds.

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What Do the Changing Mortgage Rules Mean for Lenders?

The real estate market in the US has started recovering from the subprime lending crisis. Now mortgage executives are preparing to deal with a new mortgage business model that places special emphasis on protecting the interests of borrowers. In order to deal with the change in the lending landscape, lenders have to modify their business models. This requires making adequate changes in the underwriting process and employing highly advanced information technology. The goal is to improve the borrower's buying experience. The lender also needs to standardize processes and procedures.

New mortgage rules require the lender to comply with stricter regulatory guidelines. That means the lender now has to adhere to the spirit as well as the letter of the law. This requires developing a customer-centric lending model that complies with GSE underwriting guidelines, consumer protection and banking institution safety. This will not be possible if the technological and organizational infrastructure do not evolve, innovate, or compete.

The federal government now expects lending institutions to consider consumer experience when they deliver financial services. Failure to do so may result in hefty fines and penalties.

How to comply

Lenders now need a team of well-qualified risk analysts, legal consultants, process engineers and consumer advocates to ensure that they comply with the guidelines. In order to keep all employees informed, lending institutions may need to conduct comprehensive training programs. This also requires significant investment in IT infrastructures.

Changing underwriting norms

Before making the loan, the lender has to assess the borrower's current and future capacity to repay the loan. In addition, the lender is not allowed to make a loan to a borrower who cannot afford it. It is not hard to see that in its bid to protect consumer interests, the government is effectively denying financing to a section of borrowers who do not have a reliable source of income to qualify for the mortgage.

Refinancing loses demand

Another development is the reduced demand for refinancing. This is forcing lending institutions to change the mix of products they offer. While refinancing products were quite popular in 2012 and 2013, they have fewer takers now.

Refinance volume is likely to drop to around 388 billion USD in 2014. In 2013, the amount was 967 billion USD. To deal with the decreasing demand for refinancing, lenders are shifting their focus to jumbo lending, reverse mortgage lending and money loans.

Lenders now watch consumers and catalog the products they make to ensure that they are prepared to compete in areas where borrowers are seeking financing.

The lender has to change their mix of mortgage products to match the changing market. The market is shifting from refinance business to purchase money transactions. In addition, many purchase money borrowers now seek jumbo financing. The slowly improving economy and Federal government policy changes are driving the demand for jumbo loans. Consumers, too, are seeking larger homes.

Reverse mortgages

The aging population is fuelling the demand for reverse mortgages. These products have matured over the years and consequently older adults are increasingly looking at this option to fund their retirement years. Lenders who do not have a trained staff to originate these new products many either recruit more staff or outsource the origination work.

Conclusion

The biggest changes that lenders face today are the focus on the consumer and the need to offer a new mix of mortgage products driven by a number of economic factors.

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How Technology Helps Lenders Comply with New Mortgage Rules

The rules of lending have changed and both lenders and borrowers are aware of that. Less than a few years ago, lenders were mainly concerned about getting good deals that they would ultimately sell in the secondary market. This is no longer possible.

The Consumer Financial Protection Bureau (CFPB) has rewritten the mortgage lending rules. Consequently, mortgage executives have been asking themselves if their processes, systems and people have also changed with the times.

The new rules put a special emphasis on customer satisfaction. The government now wants lenders to listen to and respond to their consumers. CFPB relies heavily on new technology to engage customers. In addition, the bureau has made it easy for borrowers to express their dissatisfaction with the lender by reporting their experiences on the CFPB portal. The bureau's Consumer Complaint Database will store and manage this information.

Consumers are showing great interest in providing feedback. More than half of the 139,000 complaints registered with the bureau by the end of the 3rd quarter of 2013 are related to the home loan industry.

When lenders are flooded with consumer complaints they will definitely need to rely on technology to resolve the issues. 

Here are some reasons why lenders need to invest in automation to serve the borrower better:

The new rules demand it

The CFPB doesn't ask lenders to employ new technology, but lenders have no other choice because the new rules are very complex. The lender can't comply with the new guidelines without the help of technology. The legacy systems that they use at the moment are not designed to meet the specific needs of the borrowers. These systems mainly helped lenders to process home loans for secondary markets.

Executives are also interested in investing in technologies that will provide a better buying experience to their borrowers.

Emphasis on consumer satisfaction

The federal government now insists that lenders provide a better buying experience to their borrowers. Lenders have never employed people to provide customer service. Since the profit per loan is low, they will probably not be able to afford it either. In this case, automation is the only available solution.

The key is investing in technology which will help the lender use their smaller staff to deliver a better buying experience to their borrowers.

New technology helps it possible for lenders to serve more customers faster.

When profit per loan is falling and the cost of compliance is rising, having happy customers alone will not help the lender to operate profitably. Lenders also need to use technology which will help them serve more borrowers in less time. The lender will receive applications from both qualified and non-qualified borrowers. It is crucial to eliminate those applications that are unlikely to qualify early in the loan approval process. This will save time for you.

Technology also allows the lender to decide how the application should be processed.  This allows the lender to immediately alert the borrower. When the borrower knows the outcome early enough, it will increase their overall satisfaction. This is true even when the lender's decision isn't good for the borrower. Technology also helps the lender provide timely status updates.

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A Comparative Analysis of Asset-Based and Cash Flow-Based Loans

When a company gets an asset-based loan (ABL), it is putting its assets at risk. An ABL uses a company's assets as collateral. These loans are much more expensive than regular bank loans. However, they are a boon for companies that don't have a huge cash flow.   

Let’s say there is a business owner trying to get a loan. He has got more than one option. He can, for example, get a loan on the basis of his company's cash flow. If his company makes huge profits, this is the only option he needs to consider. Banks prefer this kind of lending because cash flow based loans are less risky.

What if his company doesn't make huge profits? He may still require funding. In that case, his only option is to obtain an ABL. Traditional banks don't prefer this kind of loans. Most of them don't even offer these loans. However, there are several lenders who make asset-based loans.

An ABL is based on the value of the assets. That means if a company has assets of substantial value, getting an ABL is relatively easier. The lender might still consider your cash flow, but it comes only second.

Collateral

Different lenders accept different kinds of assets as collateral, but they all insist that the assets have to be salable. Lenders will not accept assets that cannot be sold quickly. The assets that are typically accepted by lenders include equipment, machinery, real estate, accounts receivable and inventory.

When the borrower gets the loan, it gives the lender the first security interest in the collateralized assets. So if the borrower fails to make the payments, the lender can seize the collateral, sell it and recover its investment. When a borrower gets a cash flow-based loan, they don't have to offer collateral. These loans are based on the company's credit rating and expected income.

Suitability

ABLs are suitable for some businesses. In the same way, cash-flow based loans are suitable for some other companies. ABLs are usually obtained by companies that don't have a good credit rating or surplus cash flow. However, its assets should be of substantial value. Otherwise, the lender will not approve the loan.

If the company has a sizable amount of cash flow and a decent credit rating, it should consider getting a regular bank loan which carries lower interest rates.

Assessment

Both kinds of loans have their advantages and disadvantages and it is hard to say whether one kind of loan is better than the other. It depends on the credit requirements and financial situations of the borrower.

It is true that asset-based loans are more expensive because they carry a higher risk. On the other hand, they help small businesses get financing even if they don't have sufficient income to justify the amount of cash they need.

ABLs have higher interest rates and processing fees. The borrowers should be able to use the loan amount to make profits. They can, for example, use the money to buy more machinery and increase their productivity. They may also use the loan amount to make acquisitions. If they fail to use it profitably, getting an asset-based loan would be a mistake.

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