Subprime Mortgages' Modest Comeback
Bill Dallas ran two subprime lenders that collapsed during the financial crisis. Now he’s back in business and plans to start offering what he calls nonprime loans later this year through his latest venture, NewLeaf Lending, based in Calabasas, Calif. “There needs to be a solution for people who don’t fit in the box, and rebuilding nonprime lending is it,” says Dallas. This time, he says, tougher lending rules will require borrowers to put down as much as 30 percent and document their income, credit, and work history.
Lenders are returning to the subprime market, although so far the lending is a fraction of what it was before the mortgage crisis. About $3 billion of subprime mortgages were made in the first nine months of 2013, matching the year-earlier period, according to Inside Mortgage Finance, a trade publication. In 2005, subprime originations reached $625 billion.
Driven by Wall Street’s demand for subprime loans to securitize and sell to investors, lenders sold high-risk products such as exploding adjustable-rate mortgages—loans with interest rates that could triple after two years—and liar loans, also known as stated income loans, which required little or no documentation about income, assets, or credit history. Most of these loans went to subprime borrowers, those with credit scores below 660.
Federal regulators have since restricted some high-risk mortgages, and lenders now require higher credit scores from borrowers. The average score for a mortgage approved by Fannie Mae in 2012 was 761, compared with 713 in 2000. The Consumer Financial Protection Bureau’s new Qualified Mortgage standards provide some legal protection to lenders who meet certain guidelines. The rules also expose them to liability if their loans fail certain tests, like charging fees that are too high or requiring payments that, combined with other debts, exceed 43 percent of a borrower’s income.
The stiffer rules have shut out about a third of Americans from the mortgage market. The share of homes purchased by first-time buyers was 28 percent in November, according to the National Association of Realtors. In the decade ended in 2012, the average monthly rate was 40 percent.
Roberto Balcker, a Miami real estate agent, didn’t qualify for a loan backed by Fannie Mae or Freddie Mac because his commission income fluctuates. He did qualify for a loan from Citadel Servicing, which began making subprime loans last July. Citadel, based in Irvine, Calif., made Balcker an 8.75 percent adjustable-rate loan to buy a $130,000 condo in Miami’s Edgewater neighborhood in January. The rate, which is fixed for the first seven years, could jump to 14.75 percent, according to Miami-Dade County records. “If it wasn’t for this type of lending, I would still be a renter,” says Balcker, 38. “I make twice the income of clients of mine who found conventional financing, but I couldn’t qualify for a mortgage.”
Athas Capital Group in Calabasas began making subprime loans last April. “We’ve done enough loans to prove to us that it’s a product we’re going to continue to grow,” says Brian O’Shaughnessy, Athas’s chief executive officer. “The biggest thing that has held us back is that a lot of brokers don’t know the product is back.” Athas offers mortgages at 9.75 percent for borrowers with a credit score of 550 to 599 who can make a 30 percent down payment. So far all borrowers have paid on time, O’Shaughnessy says, though he declines to say how many loans have been made. “The word ‘subprime’ in a lot of people’s minds is dirty, but the product today is much different, much safer,” he says.
Subprime isn’t dangerous if the lending is done prudently, says Frank Pallotta, managing partner at Loan Value Group in Rumson, N.J., which advises mortgage investors on risk. “It’s a slippery slope if you start to get back to the products we saw in 2005 and 2006,” Pallotta says. “Any skimping on documentation and any mortgages with big rate adjustments down the road are just defaults waiting to happen.”
NewLeaf’s Dallas says investors haven’t yet shown an interest in buying up mortgages and bundling them for sale to investors. “The challenge is rebuilding an investor base,” he says. Sonny Weng, a mortgage analyst at Moody’s Investor Services in New York, says an investor base won’t be viable for a few years. “Right now investors don’t have much appetite for subprime because they got burned during the crisis,” he says. “Longer-term, you may see further development of this type of product. Investors looking for higher yields may become interested.”