Why Subprime Mortgages Are Back

Why Subprime Mortgages Are BackSubprime mortgages – once the bad boys of real estate lending – are coming back. Figures from the Federal Reserve Bank of St. Louis show that between 2007 and the start of 2013 subprime mortgages fell off the radar for most banks but now they have begun to make a significant comeback.

What happened to subprime mortgages and why have they begun to come back into the lending picture?

Subprime mortgages are a form of financing which is supposed to be a form of financing made available only to those with woeful credit, individuals who had bankruptcies and foreclosures in their credit reports, who routinely failed to pay back their debts, or who had a history of late payments.

Subprime mortgages make a comeback
However, in the mid-2000s, it turns out that most subprime mortgages were sold to borrowers who in fact qualified for better financing. A study by the Wall Street Journal showed that 55 percent of all subprime borrowers in 2005 actually qualified for FHA, VA and conventional financing. The Journal also reported that 61 percent of all 2006 subprime borrowers overpaid for their loans and that they actually qualified for lower-cost FHA, VA and conventional mortgages. (See: Subprime Debacle Traps Even Very Credit-Worthy, December 3, 2007).

Subprime Mortgages Impact Millions of Homeowners

The result of subprime mortgage overselling was that millions of borrowers were effectively overcharged for mortgage financing. Such homeowners were needlessly exposed to the type of lending which was most likely to wind up in foreclosure because of higher costs, substantial prepayment penalties and harsh terms and conditions.

Once the housing market began to go into decline in 2006 mainstream lenders began to back away from subprime lending as quickly as they could. By late 2008 and 2009 subprime loans were about as common as unicorn toes. In fact, subprime mortgages were so unappealing to most lenders that from 2009 to 2012 it appears that the Federal Reserve Bank of St. Louis did not even poll banks about their subprime mortgage preferences.

In 2012 the St. Louis Fed once again raised the question and found almost no banker interest in subprime mortgages. The picture began to change in 2013, and by the middle of the year roughly a quarter of the nation’s banks were showing a renewed interest in subprime lending.

Subprime Mortgages Make A Comeback

Why have subprime loans begun to show up once again as a lender offering?

The answer likely has to do with several trends.

First, the housing market has begun to improve in most markets and therefore mortgage loans have inherently less risk. For example, in the third quarter of 2013 the National Association of Realtors reported that existing home prices rose in 144 Metropolitan statistical areas out of 163 that they reviewed.

Second, today’s subprime mortgages are likely to be very different than the toxic loans offered between 2000 and 2006. For example, borrowers are going to be required to fully document loan applications and hefty down payments will be required, perhaps 20 to 30 percent down.

Third, the foreclosure crisis not only left more than seven million people without homes it also demolished lender profits and shareholder values. The banks who remain have no desire to repeat the fiasco and as a result have established tougher qualification standards.

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