BY RANIA OTEIFY, EDITOR
The return of subprime mortgages eems to be less-than-welcome news for almost everyone —
from the public to regulators. With these
mortgages’ recent record and presumed
role in the 2008 financial crash, seeing
them rise once again sounds alarm bells
for many industry participants.
Today’s subprime lenders, however, argue that their product offering
responds to a market need and is so
regulated that its risks are well under
control. In short, the argument is that
today’s subprime mortgages are a completely new animal. Although they still
may cater to low-credit-score borrowers,
they require full documentation, sizable
borrower equity and thorough review of
borrowers’ ability to repay.
In the wake of flagging refinance
volumes, mortgage brokers who may
be looking at this niche to expand their
portfolios must heed these changes
first. Attempting to work in this market
segment without proper understanding of its current requirements could
spell trouble and sabotage relationships with clients and lenders alike.
It is also important to keep in mind
that the subprime-market space has
shrunk drastically in the aftermath of
the financial crisis. According to data
from Lender Processing Services,
subprime mortgages made up a mere
0.26 percent of the U.S. mortgage
market in the year between July ’ 12
and June ’ 13, compared to 12. 6 percent
bet ween July ’05 and June ’06.
In addition, today’s subprime lenders
are mostly nonbank lenders that cater
to borrowers who don’t fit the strict
criteria of traditional lenders. Subprime
lenders aren’t working in a regulatory vacuum, however. In fact, they are
subject to many of the various regulations brought about by the Dodd-Frank
Wall Street Reform and Consumer
Protection Act and the supervision
of the Consumer Financial Protection
Bureau (CFPB). They are also under
pressure from their own investors, the
public and their self-imposed safeguards.
Does the return of subprime mortgages
signal a new housing bubble in the making? This is just one of the concerns
typically raised in relation to the comeback of this type of lending. Lenders
are aware of market concerns and the
stigma associated with the word “
subprime.” To distance themselves and
their products from the troublesome
loans that contributed to the financial
crisis, they have been creative in their
marketing of these loans.
For example, Athas Capital Group
describes its nonprime loans as “sane”
and calls the company an “alternative
lender,” according to its principal
officer, Brian O’Shaughnessy.
“Technically it is a subprime product,
[but] we call it alternative lending,”
Similarly, Citadel Servicing Corp.
avoids the word “subprime.”
“We don’t market our loans as sub-
prime. We consider them as nonprime
because ‘sub’ sounds just crude and
subordinate,” says Kyle Gunderlock,
Citadel’s head trader and director.
These strategies aim to create a positive perception of the subprime offering,
and also reflect lenders’ under-stand-ing of its new role as an alternative to
traditional loans, which recently have
become elusive for many potential homeowners. “There is a lot of concern out in
the world — and more importantly, via the
regulators — of how we got into this crisis.
I do believe that there is a need for
some type of rebranding, which will
come over time,” Gunderlock says.
New and improved?
Labels aside, how different are today’s
subprime products from the mortgages that were handed with little
discretion to nonqualified borrowers
and helped lead to the crisis? Lenders
have many differences to list that go
beyond the FICO score of the borrower
and the pricing of the loan.
“If you think about [subprime] loans
prior to the crisis, prior to Dodd-Frank
and the settlement, they had many
different components — documentation, the degree to which borrowers
provided information, loan to value
(LTV), etc.,” says Christopher Whalen,
managing director and executive vice
president of Carrington Holding Co. LLC.
“When you run the clock forward to
today, and you look at both Dodd-Frank
and the settlement, the first thing you
notice: We now have a statutory cap
that describes whether a loan is high-priced or not — that is 6. 5 percent.
You’re no longer allowed to have any
prepayment penalties, etc.” he says.
“Such regulatory changes have
curtailed or eliminated the ability of
lenders to make liar loans and all of
the [practices] that contributed to
lawsuits with some banks and with
respect to nonagency mortgage secu-
rities,” Whalen adds.
Some lenders that are involved in
today’s subprime lending say that
they are doing business in a different,
more prudent way simply because
of their background. “Not only is the
overall regulatory environment different and some would argue not for the
better, but most alternative lenders
are hard-money lenders and they are
very much geared toward large downpayments [and] lower LTVs,” says
Within that formula, today’s subprime
borrowers must have more skin in the
game, which reduces lenders’ risk. “A
large equity position by homeowners is more of a guarantee that they
will keep making the mortgage payment,” O’Shaughnessy says. “I truly
believe the main difference between
subprime loans in the past and loans
today is that, in the past, there was so
little commitment from the borrower in
terms of LTV. Today, there is much more
This significant equity contribution
is possible because today’s subprime
clients are not limited to borrowers
with low credit scores or struggling
with unemployment. According to
O’Shaughnessy, clients are divided into:
• The non-owner occupied borrowers
who are buying a rental or a property
for a fix and flip, where they turn a
profit or take down a sale quickly and
then refinance into an A-paper loan.
• Borrowers with high credit scores
who can’t prove their income or ability
to repay in a traditional bank way
like providing tax returns — perhaps
for being self-employed.
• Borrowers with less-than-bankable
credit, who are taking subprime loans
as a stepping stone that enables them
to get in a house until they improve
their situation and move on to an
A-paper refinance loan.
In addition to regulatory scrutiny and
the efforts of the CFPB to protect
borrowers, lenders are under pressure
from their investors. “You have an
equally important investor base that
is willing to securitize or put money
in a product that has a good opportu-
nity to maintain profitability into the
future,” says Gunderlock.
“There is a consciousness out there
that is regulating the cash flow to
these lenders, as well as a regulatory
hurdle to safeguard the borrowers.
I don’t think in today’s environment
there is a lot of wiggle room for lenders
to go astray,” he adds.
That being said, lenders must
remain vigilant of their own underwriting practices. “They don’t want to get
on the wrong side of either of those
two parties and cut their own arm off
to save their hand,” Gunderlock says.
With these market changes, it is important
that brokers and originators also change
their old perception of how lenders process and underwrite subprime deals.
Lenders often cite the assumption that
subprime lending is less regulated as
one of the most common misconceptions
“It is a common theme that a broker
says, ‘You’re a subprime lender or a
hard-money lender; you can do whatever you want.’ The alternative or
subprime-lending space is more highly
regulated even than bank loans,” says
Brokers who know how to approach
and handle subprime deals adequately
will be able to capitalize on the opportunities that exist in this niche market,
especially as increasing interest rates
could impact their client base.
“There will be an increase in rates, and
brokers who only rely on a ‘decreasing
your rates’ mentality for a marketing
pitch [will do] a disservice to themselves.
They need to focus more prudently on
adding a tangible benefit to the borrower,”
• • •
Subprime mortgages return, but with a twist
Although only time will tell how
today’s subprime mortgages will fare,
a combination of regulatory require-
ments, public awareness and lenders’
lessons that have been learned through
the past few years should provide a
good guide to steering clear of troubled
deals. Mortgage brokers and originators
should be supportive of more prudent
lending that keeps the market healthy
for everyone involved. •
rania oteify is editor of Scotsman Guide.
Reach her at (800) 297-6061 or
“Today’s subprime lenders are mostly nonbank
lenders that cater to borrowers who don’t fit the
strict criteria of traditional lenders.”