Subprime mortgages are back - with a new name
The home loans that caused the housing market to crash in 2008 are returning under a different name — nonprime loans, though with more documentation than the subprime loans where it seemed like anyone with a pulse could get a home loan. They’re replacing subprime mortgages as a new form of bad credit mortgages, but with some safeguards.
Subprime mortgages burst the housing bubble by giving home loans to people who couldn’t afford them. They were referred to as ninja loans, where applicants could get a home loan with no job, no income and no assets. A down payment wasn’t required sometimes, and buyers with poor credit scores were accepted, as were those with delinquent payments on their credit reports.
New regulations prohibited lenders from loaning to people who couldn’t afford the loans.
Nonprime loans must adhere to the rule changes, but they’ve been adapted in ways that still cater to people with low credit scores. Still, nonprime loans are considered safer than subprime while still helping people with low credit scores buy homes.
“Everybody has this very negative impression of these products,” says Raymond Eshaghian, president of GreenBox Loans, a wholesale lender based in Los Angeles that specializes in nonprime loans, also called non-QM, or non-qualified mortgage loans.
Prime vs subprime
To get the best home loan rates, a “prime” credit rating is offered for a high credit score to someone who has on-time payments that prove they can manage their finances, says Alen Kadimyan, CEO of IEI Realty in Glendale, Calif.
That can allow someone to qualify for a conventional mortgage and get the best rate terms. They pose a lower risk for lenders, and are thus offered better loan terms, Kadimyan says
A “subprime” credit rating of as low as a 500 FICO credit score poses a higher risk that results in higher rates, he says. The average credit score for a nonprime mortgage is 660, though someone with a 580 credit score could qualify if they had a 30 percent down payment. FICO credit scores range from 300 to 850, and a score above 640 has historically been considered prime credit to quality for most mortgage programs at the lowest rates.
Too risky for Fannie and Freddie
Subprime loans were once allowed to be sold by lenders to the government-backed agencies Fannie Mae and Freddie Mac. Nonprime loans, however, aren’t qualified to be purchased by the agencies.
If Fannie and Freddie consider nonprime loans too risky, it can make it difficult for borrowers to get out of the loans once they’ve improved their credit scores.
Without Fannie and Freddie, nonprime loans are still offered by another government agency, the Federal Housing Administration, or FHA, says Andrew Weinberg, principal at Silver Fin Capital Group in Great Neck, N.Y.
“FHA loans, which have a government guarantee to induce lenders to make these loans, offer down payments as low as 3.5 percent, and allow borrowers to have genuinely poor credit, and no post closing reserves,” Weinberg says. “These loans never went away. But they do require that you have income.”
Nonprime lions are in the “non-QM market,” which are non-qualified mortgages that are outside government prescribed underwriting guidelines, he says.
With a qualified mortgage, lenders are “off the hook legally” with the loan, leaving any potential problems to programs such as Fannie and Freddie, says Adam Smith, president of the Colorado Real Estate Finance Group in Greenwood, CO. With nonprime loans, lenders must follow the federal rules on documentation needed to prove a buyer can afford a home, among other things.
“The lending mentality is that the consumer is going to default,” Smith says of nonprime loans. “The property is going to go into foreclosure.”
Differences of nonprime
Unlike subprime mortgages, nonprime can require down payments of 20 percent, creating a lower loan to value ratio, or LTV.
Nonprimes don’t allow a FICO credit score as low as 500, as subprimes did, though around 560 is possible. The lower the credit score, the bigger the down payment needed for a nonprime loan. Someone with a 580 FICO would need a 30 percent down payment, says Eshaghian. FHA loans can be easier to get, allowing scores of 579 or below with a 10 percent down payment required, though lenders may have their own requirements.
“There isn’t 100 percent financing anymore,” he says.
A credit score isn’t an end-all, be-all, Smith says. Employment is a major factor, he says, and nonprime loans are popular among self-employed home buyers who can’t provide proof of income as easily as someone with a full-time job. There are no set guidelines for nonprime loans, which lenders look at in a case-by-case basis, he says.
One of the biggest differences of nonprime loans is their length: 40 to 50 years at fixed rates that leads to paying more interest, compared to conventional 30-year fixed mortgages, Kadimyan says. If a “teaser rate” is offered — such as on an adjustable rate mortgage — it could only last a few years and then adjust according to the index it’s tied to.
For example, that rate could be fixed for five years at 7 percent interest for someone with a 580 credit score, Eshaghian says
There are also interest-only nonprime loans that don’t reduce the principal loan amount.
Nonprime loans are primarily “offered by wholesale banks you’ve never heard of” that are small, Smith says. They’re found through brokers.
Who wants a nonprime mortgage?
Along with people who have poor credit, nonprime mortgages could be used by anyone with short-term financial problems, advocates say.
“Borrowers have been starving for these programs and really there’s a large market for these options,” Eshaghian says, such as couples going through a divorce. A bankruptcy may be another reason to get a nonprime home loan, he says, and actually may be the best type of borrower because their debt is eliminated in a bankruptcy.
“If they wanted to buy a home, they are basically the best buyers on Earth,” he said of home buyers who have had a bankruptcy.
Hopefully, they and others clean up their credit in five years and then can refinance into a better loan, Eshaghian says.
It takes two years for a bankruptcy to be removed from a credit record, and nonprime borrowers should spend that time paying off their credit bills and improving their credit score, says Cara Pierce, a housing counselor at Clearpoint, a credit counseling service.
“People feel pressured, especially when the housing prices go up or the interest rates rise,” Pierce says of home buying fever. Instead, she tells clients that they don’t really need to buy now, and that they can avoid nonprime loans and other such products by just spending six months or so improving their credit score.
“I try to caution people against that panic behavior,” she says. “The right time to buy a house is when you’re ready to buy the house.”