Some would say that subprime loans are back. But they're not like the subprime loans that gained notoriety during the housing bust.
Wells Fargo hit the news recently with the announcement it had dropped its minimum credit score for FHA-insured mortgages from 640 to 600 (the maximum is 850) — into subprime territory.
Wells isn’t the only lender lowering its requirements. “In recent months, a handful of lenders have said that they’re willing to go as low as 580,” writes The Wall Street Journal.
The change doesn’t apply to refinances, only purchase mortgages, the Journal says. (Find out if you qualify from a bank or mortgage broker.)
Borrowers with FICO scores of 720 and higher still get the best rates, though.
Are subprime mortgages back or not?
These moves inspire talk that subprime mortgages are back. But, are they really? As The Wall Street Journal explains, these “FHA-backed mortgages are fully documented, fixed-rate mortgages — not the crazy loans that fueled the subprime mortgage crisis.”
“Subprime” isn’t a precise term. It’s used to describe some lenders, or certain types of loans. It’s also used to describe borrowers with FICO scores under 620 or 640 or 660, depending on who’s talking.
It also describes certain risky mortgage products sold at the end of the housing boom with features like no down payments, no documentation and super-low teaser interest rates that might double or triple after an introductory period.
“Most of these loans went to subprime borrowers, those with credit scores below 660,” Bloomberg Businessweek says.
Subprime also is used to describe lenders who sold risky mortgages or approved borrowers for mortgages they almost certainly couldn’t afford to keep up.
Like old subprime mortgages? No.
Are those infamous loans really back in play? No — not the risky features, anyway. Those features are banned on “qualified” mortgages, those most widely available. Qualified mortgages have new consumer protections. Lenders who abide by qualified mortgage rules are shielded from consumer lawsuits. (Investopedia explains qualified mortgages.)
The federal rules, called for in the Dodd-Frank Act, went into effect at the beginning of this year. They’re enforced by the Consumer Financial Protection Bureau.
On the other hand, yes. Sort of.
You could make a case, however, that subprime loans are back, based on the increased lending to borrowers with lower scores. Wells Fargo is the country’s biggest mortgage lender, so its move made news.
To avoid the taint associated with the word “subprime,” lenders are calling these loans “another chance mortgages” or “alternative mortgage programs,” says Reuters.
Qualifying for a low-credit-score mortgage
Qualifying for a mortgage with a low credit score requires jumping through a lot of hoops – many more than in the pre-bust days. Not everyone with a low score gets approved.
FHA, which insures mortgages, requires credit scores no lower than 580 and a down payment of at least 3.5 percent. With a credit score below 580 you’ll need to contribute at least 10 percent of the loan amount. (Here are FHA rules.)
FHA’s fees are rising and it requires mortgage insurance, making these mortgages increasingly expensive. Mortgages backed by Fannie Mae and Freddie Mac are cheaper, but they’re harder to get.
FHA’s requirements are just the start of a borrower’s hurdles. Lenders add additional requirements (“overlays”). Most demand higher credit scores than FHA does.
Wells Fargo’s criteria for low-credit borrowers are “strict,” Reuters says. They include “demonstrating their ability to repay the loan and having a documented and reasonable explanation for why their credit scores are subprime.”
In addition, the new federal mortgage rules require tougher scrutiny of mortgage applications. These rules require lenders to look at eight areas before approving a borrower if the lender wants protection from borrower lawsuits.
The eight points:
- Income and assets.
- Child support or alimony obligations.
- Credit history.
- Monthly payments on debts.
- What you can afford to pay monthly on a mortgage.
- Other mortgage costs, like home and mortgage insurance and property taxes.
- Your remaining income.
There’s an even more costly option for low-credit-score borrowers — a smaller non-bank lender. They can sell “non-qualified” mortgages that fall outside the federal qualified mortgage rules. They are likely to charge higher interest rates and require bigger down payments. So far, non-bank subprime mortgages aren’t a big part of the mortgage market.
MSN Real Estate describes one non-bank lender:
Citadel Servicing Corp. in Irvine, Calif., is one of very few lenders lending mortgage money to borrowers with FICO scores as low as 500. It began in April (2013) making fixed-rate and adjustable mortgages of $50,000 to $750,000 using money raised from private investors. These mortgages don’t qualify for government backing, which makes them considerably more expensive.
Citadel CEO Dan Perl calls himself a “nonprime” lender. The term “subprime” denigrates borrowers, he says. “We’re talking human beings who have had some bumps in the road.”
Citadel may charge interest rates over 10 percent, Reuters says. Prime borrowers, for comparison, pay an average of 4.34 percent right now on a 30-year fixed-rate mortgage.
Learn about qualifying for a mortgage or improving your credit score from one of the local HUD-approved agencies that offer credit counseling and first-time homebuyer counseling for free or at low rates.
Have you gotten a mortgage recently despite a low credit score? Post a comment about your experience below or on our Facebook page.