Are Subprime Mortgages Dying Or Dead?

Subprime mortgages are an endangered species. The problem is not that such loans can’t be made under Wall Street Reform, and it’s not that such loans won’t be made, it’s just that there will be a lot fewer of them.

Subprime mortgages are appropriate for individuals with poor credit histories because such borrowers Old Stone House are seen as substantial credit risks. For instance, the FHA accepts borrowers with 3.5 percent down as long as their credit score is 580 or above. Below 580 you need at least 10 percent down.

So we could define subprime borrowers as those with credit scores below 580, though some lenders might set the bar at 620 or even 640.

Under the new mortgage rules which went into effect January 10, 2014, lenders can freely make subprime loans. However, if they want to offer subprime financing and have the loan defined as a qualified mortgage within the safe harbor created under Dodd-Frank then they must follow a number of guidelines. For instance, monthly debts cannot generally exceed 43 percent of the borrower’s income. Another standard limits lender compensation to fees and points worth not more than 3 percent of the loan amount for mortgages of $100,000 or more.

Lenders might also make loans that are not “qualified mortgages” but doing so creates a different set of issues: For instance, the lender faces a lot more liability, not a good result at a time when lenders have recently paid out legal settlements of more than $100 billion to resolve past claims from borrowers, mortgage investors and government agencies.

Another option is to make smaller loans, mortgages which allow larger fees. According to the Consumer Financial Protection Bureau, the following scale applies:

  • For mortgages with an initial balance of $100,000 or more fees and points cannot exceed 3 percent of the loan amount.
  • For mortgages with an initial balance of more than $60,000 but less than $100,000 the fees and points cannot exceed $3,000.
  • For mortgages with an initial balance of more than $20,000 but less than $60,000 the fees and points cannot exceed 5% of the total loan amount.
  • For mortgages with an initial balance of more than $12,500 but less than $20,000 the fees and points cannot exceed $1,000.
  • If a mortgage is less than $12,500 then points and fees cannot exceed more than 8 percent of the loan amount.

Subprime Mortgages

From a lender’s perspective subprime mortgages are difficult because they may not generate enough income to justify the work required to produce a profitable loan, especially with smaller mortgages. One solution, according to the Mortgage Bankers Association, is to allow higher points and fees for loans of as much as $150,000 rather than the current cut-off of $100,000.

Raising the high-fee threshold to $150,000 is unlikely because too many borrowers would be exposed to more-expensive loan fees, including borrowers with solid credit histories. For instance, the typical midwest home now sells for just $151,100 according to the National Association of Realtors, meaning that most borrowers in midwestern states would suddenly face higher fees if the rule is changed.

Meanwhile, if you’re a home buyer or looking to refinance, speak with as many lenders as possible if you need subprime mortgages. In particular, as an alternative check into FHA mortgages and speak with local community housing organizations.

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