Photo (cc) by nikcname
After risky mortgages crashed the housing market and took the economy to its knees, you may have thought you’d heard the last of subprime mortgages and home loans with features like interest-only payments.
But, no. These are, after all, products that made billions of dollars for lenders, investors and traders. And, recently, business has been slow for mortgage lenders, reviving their interest in some of the most marked features of the subprime-mortgage lending boom.
The mortgages that took many homeowners into foreclosure after the housing crash typically had one or more toxic elements. Those include:
- Crazy structure: The loans themselves were poorly built and almost guaranteed to cause trouble. You’ll probably recall mortgages with cheap interest-only (I/O) payments or mortgages with “exploding” interest rates that started low and then shot up to create unmanageably high monthly payments.
- Accessibility even to borrowers with poor credit scores: Great numbers of these impractical loans were sold to people with bad (subprime) credit — credit scores between 300 and 600. (Nonprime credit includes scores between 601 and 660; prime scores are over 601.) Generally, subprime borrowers find it more difficult and expensive to get loans. That’s because lending to them is riskier.
- Ridiculously lax requirements: In the subprime heyday, lenders sometimes assessed a borrower’s ability to repay an adjustable-rate loan based only on the cheapest introductory payments. They didn’t take into account how unmanageable payments would become after the interest rate began to rise.
Today, a few of those familiar features are making a comeback. You can find ultra-low down payments, interest-only provisions and low credit score borrowing. This time there are new twists, though. If lenders want protection from homeowner lawsuits, they must scrutinize a borrower’s ability to repay the mortgage under strict new guidelines put in place by the federal Consumer Financial Protection Bureau since the crash.
Or, borrowers can pay more and face different requirements, shopping among the growing number of lenders who work outside the government standards.
Low, low down-payment mortgages
You probably know that you can get an FHA loan with a down payment as low as 3.5 percent. But did you know that conforming mortgages (backed by Fannie Mae and Freddie Mac) now are available at 3 percent down? As CNN reported earlier this year:
Fannie Mae and Freddie Mac guarantee more than half the country’s mortgages. At the end of 2014, the two government-backed companies announced plans to slash minimum down payments from 5 percent to 3 percent.
The new program from Fannie Mae went into effect in December, and the one from Freddie Mac will begin in March. Both are for first-time homebuyers or those refinancing their mortgage, and the Freddie Mac program is restricted to low-income borrowers.
With less than 20 percent down, you’ll need to buy mortgage insurance for Freddie Mac and Fannie Mae (conventional) mortgages. But National Mortgage News, which covers the mortgage business, says “some lenders, including TD Bank, are also offering a 3-percent down-payment loan program without mortgage insurance.”
One of the features that made headlines in the housing crash was the interest-only payback option. New regulations ban I/O features for loans that qualify for government protection. Among other things, they require a borrower’s monthly debt-to-income level to stay below a certain threshold. Loan fees and interest rates are limited.
But, from lenders whose mortgages don’t meet the government standards, borrowers can find adjustable-rate mortgages that, for a period of time, allow interest-only payments. Such payments do not reduce the loan’s balance. When the interest-only period ends and your payments start reducing your loan balance, the payments can increase, sometimes astronomically.
Today’s I/O home loans are not cheap. High costs and tough requirements, like high down payments and good credit scores, make them almost exclusively a product for wealthy borrowers, according to The Wall Street Journal (subscription required).
Mortgage expert Guy Cecala tells The Journal that the typical I/O loan is a jumbo mortgage that’s larger than government-backed conventional loans (more than $417,000 in most places and $625,500 in certain higher-priced areas.)
For wealthy borrowers
“Most lenders think interest-only mortgages are very safe because the borrowers have strong credit profiles and generally put down large down payments,” Cecala says, regarding new I/O mortgages.
I/O borrowers need a credit score of 740, a down payment of 35 percent or more and a 43-percent debt-to-income ratio to qualify, one lender told The Journal. (To learn about debt-to-income requirements, read It’s Not All Credit Scores: Other Things Your Lender Might Be Looking At.)
Why would never paying down a mortgage balance be attractive to wealthy, savvy borrowers? The Journal says I/O mortgages have strategic value in some cases:
Interest-only jumbo-mortgage holders typically have the assets and/or income that would enable them to make monthly principal payments, but instead they use the loan as a money management tool, Mr. Wind, of EverBank, says. “We get a lot of requests from people who work with financial planners and are trying to maximize their cash flow,” he adds.
Other I/O borrowers may have uneven incomes, making it difficult to obtain a conventional mortgage, or they expect to hold a property only for a short time.
Lower credit scores
Last year, Wells Fargo and other conventional lenders lowered their credit score requirements for mortgage borrowers after keeping them at restrictive levels since the crash. (Read: Can You Get One of The New Subprime Mortgages?)
But lowering credit score requirements somewhat does not mean a return of loose lending. Many borrowers still have trouble meeting mortgage requirements. (For more on that, read: How Come You Still Can’t Get a Home Loan?)
At the same time, even borrowers who recently went through foreclosure or bankruptcy are getting mortgages, The Wall Street Journal writes in a separate article. But these loans, riskier for investors and lenders, typically are privately held and may not meet government qualifications.
“The loans are often funded by or sold to private-equity firms, hedge funds and other investors who are seeking investments with higher yields and are prepared to take on more risk,” The Journal writes.
The lending landscape today is by no means the Wild West of the mortgage boom. But a growing appetite for profit continues to fuel lending to riskier borrowers who are willing to pay higher prices.
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