The media has touted the troubles facing subprime mortgage lenders over the last few days, and with good reason.  Simply pull a stock quote for Accredited Home Lenders or New Century and you can see the havoc that risky lending and high default rates have wreaked on these once-proud businesses. 

However, what the media has not fully explained is the potential impact to homeowners and borrowers.  As a mortgage broker, I have some insights into changes in the market, and would like to share them with you.

As recently as January of 2007, just about anyone could qualify for anything.  If you had a pulse and a social security number, you could obtain a mortgage.  The rate may be astronomical, the terms difficult to swallow - but you could qualify.  Subprime lenders worked miracles, taking credit files that no one else would even consider and turning them into closed loans.  Obviously, these loans were risky: bad credit, no credit, shaky income, no income, high loan-to-value ratios…but for many individuals, these loans broke down a barrier to entry into the housing market. 

One of the best ways to improve a bad credit score is to obtain a mortage and make timely payments on it.  Accordingly, if low-credit individuals could qualify for a loan and make the payments for a year or two, the credit score would sometimes jump upwards of 100 points and make attractive traditional financing possible 12-24 months down the road.  I saw this scenario play out with more than a few borrowers, who are now sitting on solid financial footing as a result of their new home purchase and understanding of the importance of good credit.   

For a bulk of subprime borrowers, however, the story did not work out so happily.  They skipped a payment, then a few, and before long were facing foreclosure.  The investors who held their loans are not in the real estate business, and a foreclosure often means a major financial loss.  As the foreclosure problem escalates, these investors (big investment firms like Merrill Lynch and Charles Schwab) have begun to pul their funding. 

As a result, nearly two dozen subprime lenders have filed for bankruptcy with more soon to follow.  The still-solvent subprimes have tightened their guidelines, dramatically.  So dramatically, in fact, that as of last Friday subprime lending as we knew it last year no longer exists. 

For example, my most solvent subprime lender has instituted the following new guidelines last Friday:  No loans over 90% LTV.  Anyone with credit scores less than 660 will be required to verify $3,000 in disposable income (after bills) each month.  The minimum credit scores that they will lend on went from 520 to 600.  No exceptions.

This is a massive shakeup in the lending market.  For the millions of adjustable rate mortgage holders set to reprice in the next 12-36 months, refinancing may not be an option.  New homebuyers will be required in many cases to bring at least 5% if not 10% of the purchase price to closing, in addition to closing costs.  The housing market in many areas will be hard hit.  

Who might benefit from this?  Investors, landlords, and homebuyers with good credit and the ability to save.  The correction in the housing market that may result from these changes could drive home prices down, increase rents, and give the Fed reason to consider a decrease in interest rates.  If you don’t have some assets and good credit, however, you won’t be able to take advantage of lower prices and favorable interest rates. 

As a quarterlifer who may be contemplating a home purchase in the near future, I would encourage you to built up a significant reserve of funds - at least 10% of your expected purchase price, before seriously considering a purchase.  Stay on top of your credit as well.  Go to annualcreditreport.com and pull a copy of your credit and dispute any errors.  Make all your payments on time.  Make all your payments on time!  And keep your credit card balances as low as possible with respect to your limits.

If you are a buyer being displaced by the new changes, you have some options.  Sites like Prosper.com make it possible to obtain unsecured funding for a new home purchase.  Or sit tight and save your pennies.  Before long the pendulum may swing back in the other direction, if new investors start channelling money into the subprime sector.

If you have any questions regarding the new changes, credit repair, mortgages, or other financial questions, email me at admin@quarterlifefinance.com.

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This entry was posted on Tuesday, March 13th, 2007 at 12:16 pm and is filed under Mortgages. You may e-mail this post to a friend. You may print this page. Responses are currently closed.