Another One Bites the Dust

Subprime lenders are those who lend money to those who do not meet the creditworthiness standards of the strict lenders.  This segment of the mortgage business has exploded in recent years as the industry has loosened its credit standards. 

Those of us who originate more traditional mortgages and are used to making sure that our clients are creditworthy have shuddered as the subprime guys expanded so rapidly. First, they started lending to borrowers with poor credit. It was more profitable lending to people who had fewer opportunities. They charged very high fees, like 6 points on a $200,000 loan. That equals $12,000, and maybe the loan officer got to keep half of that. That kind of fee is simply not correlated with the amount of work required, HUD’s test for “reasonable compensation.”

You can imagine a new loan officer whose last job paid minimum wage, equal to about $14,000 PER YEAR, all of a sudden being able to make that much every month on just a few loans. That kind of compensation attracted some very shady people into the loan business. They could make lots of money without much fear of regulatory restraint.

Then subprime lenders started doing no-income-verification ("no-doc") loans.  Unless you came to town on a turnip truck, you’d have to believe that on most of these applications the income was exaggerated, meaning no one would lend if they knew the borrower’s real income.

Then they expanded into no-down-payment loans. Doing loans for people with poor credit, undocumented income, and no down payment means that you lend to anyone. One bank I heard of recently does not even require documentation of citizenship or legal residency, read: “They will do loans to illegal immigrants.”  Well, some of that profligacy is now coming home to roost.

Subprime lending giant Ameriquest settled allegations of unethical and illegal conduct earlier this year by paying $325 million in fines and funding rebates to customers who were abused by their lending practices. They closed over 200 offices.

More recently, H&R Block, which originates subprime mortgages through it subsidiary Option One, announced a write-down of over $100 million due to the necessity of re-purchasing some bad loans, ones that went into default shortly after they were originated.

In the latest chapter in this saga, ECC Capital, another Orange County, California based subprime lender, announced that it is selling its subprime origination operations and getting out of that business. The buyer is Wall Street giant Bear Stearns which buys such loans and re-packages and sells mortgage-backed securities. ECC stated that its shareholders are likely to get about $.80 per share from the transaction, a loss of almost 90% of its value when it went public at $6.75 per share. 

Bottom line: there is already a lot of blood in the streets in “Subprimeville,” and there is likely to be a lot more.  What does this mean for potential customers?

First, it is important to understand that subprime lenders will only originate loans they can sell. If they can’t sell it, they won’t do it.  Thus, if the people who buy these loans, Bear Stearns and others, start taking enough hits, they are going to tighten the standards on what they will buy.  This suggests that “more prudent lending standards” are likely to be imposed on this segment of the market and that will put a rein on what subprime lenders will do.

 When lenders start lending people 100% of the purchase price of a home in a housing market that is showing signs of weakness – i.e. they are the ones taking all the risk -- they ought to be more careful to whom they lend.

I am all for improving homeownership opportunities, and that means not just lending to new households. It means digging deeper into the barrel of buyers out there and helping them too. But rather than lend money to everyone who applies, I think we ought to do a better job of educating these potential homeowners beforehand. We ought to help them straighten out their credit practices and credit scores, help them understand benefits of devoting a portion of their income to savings, and to help them make intelligent choices when it comes time to buy. That way, home ownership can be a joy and not a burden..

You will see this theme throughout the educational material on this website. It is all here for YOUR benefit, and I hope that you will find it valuable and that someday you will become a happy homeowner.

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