The Trouble with Alt-A Loans

Alt-A loans are a category of mortgages that offer borrowers with good credit the convenience of not having to fully document and verify their income. While these loans are considered more secure than subprime loans, they have become troublesome due to a high volume of defaults.

Mortgages that are known as "Alt-A" loans are conveniently attractive, especially for people whose income is difficult to verify through traditional paperwork such as pay stubs and tax returns. Those who are self-employed, those who earn a substantial income by receiving tips in cash, and those whose income is based on sales commissions sometimes, make more money than their documents reflect. Because this presents a challenge when applying for a mortgage, these consumers are often willing to pay a higher interest rate in exchange for a low-documentation Alt-A loan.

Liar loans

Mortgage investors are happy to offer Alt-A loans, because they're a safe bet and pay higher interest. To qualify for this type of loan, you must have good credit, which makes investors feel more secure, especially compared to other high-interest loan investments, like subprimes. But Alt-A mortgages have recently earned the nickname "liar loans," because so many borrowers exaggerated their stated income in order to qualify for bigger loans and more expensive houses. Those high-priced homes carry higher monthly payments that borrowers cannot realistically afford, and that's where the problems start.

According to Standard & Poor's, the delinquency rate on Alt-A loans has quadrupled since 2004. To add insult to injury, another $1 trillion of adjustable rate mortgages are scheduled to reset this year. As they do, the monthly payments of many homeowners will skyrocket. But homeowners who want to refinance out of expensive mortgages are finding that the value of their homes is shrinking, thanks to a crumbling housing market. With so many bad loans across the country, lenders have tightened their rules, making it harder to qualify for a new loan or a refinance. With less equity to borrow against and more hurdles to jump, many holders of Alt-A loans are in deep financial trouble with no way out of the mess.

To tell the truth

On the other hand, if you're a responsible borrower who's not prone to hyperbole when it comes to declaring your annual income, an Alt-A mortgage may still be a viable resource. Because of caution among lenders, If you're applying for an Alt-A, you need a high credit score. Also, be prepared to pay a substantial down payment. Keep in mind that Alt-A loans carry higher interest rates. As troubles expand across this market, fewer investors will be willing to support them. That may drive their interest rates even higher. You may prefer to apply for a conventional loan instead, even if you only qualify for a smaller amount. With the prices of homes falling, smaller loans do buy bigger houses. That's the silver lining in the cloud if you're shopping for real estate this year.