|
22 March 2004
"I hear terrible things about sub-prime
lenders. What are they, and how can I avoid them?"
A sub-prime lender is one who lends to
borrowers who do not qualify for loans from mainstream lenders. Some are
independent, but increasingly they are affiliates of mainstream lenders
operating under different names.
Sub-prime lenders seldom if ever identify
themselves as such. The only clear giveaway is their prices, which are uniformly
higher than those quoted by mainstream lenders. You do want to avoid them if you
can qualify for mainstream financing, and I�ll indicate how shortly.
The
failure to qualify for mainstream financing is due primarily to low credit
scores. A very low score will disqualify. A middling score might or might not,
depending on the down payment, the ratio of total expense (including debt
payments) to income, ability to document income and assets, and other factors.
Other factors that can enter the equation
include purpose of loan and property type. For example, a borrower who is weak
on some but not all of the factors indicated above might squeak by if purchasing
a 1-family home as a primary residence. But the same borrower purchasing a
4-family home as an investment might not make it.
Sub-prime lenders base their rates and fees
on the same factors as prime lenders. For example, rates are higher the lower
the credit score and the smaller the down-payment. However, the entire structure
of rates and fees is higher at sub-prime lenders to cover the greater risk and
higher costs of sub-prime lending.
A higher percentage of sub-prime than of
prime loans go into default. Among loans that don�t default, a higher
percentage prepay early. Sub-prime lending costs are also higher because more
applications are rejected and marketing costs are higher.
The development of the sub-prime market has
made mortgages (and home ownership) available to a segment of the population
that otherwise would have been shut out of the market. That�s the good news.
The bad news is that some borrowers who are eligible for loans from mainstream
lenders end up in the sub-prime market. They are prime borrowers but they pay
sub-prime prices.
This happens partly because of the
difficulties some borrowers can have in determining whether or not they qualify
in the mainstream market. Underwriting requirements can differ from one
mainstream lender to another, so it is quite possible that a borrower with
problems, who is not eligible at one lender, will be eligible at another.
Qualifying a borrower with problems,
furthermore, may require a great deal of time, effort and skill by the loan
officer or mortgage broker. Some will take the easy way, when borrowers permit
it, and classify them as sub-prime.
However, the main reason some prime borrowers
end up paying sub-prime prices is that they are solicited by sub-prime lenders
and go along with the deal pitched to them without ever contacting a mainstream
lender. Very few sub-prime loan officers will give up a commission by referring
a qualified applicant to a mainstream lender. The deal will very likely go down
at sub-prime prices, therefore, regardless of how qualified the borrower may be.
Sub-prime lenders market aggressively to
home-owners who already have mortgages. A major pitch is the cash that borrowers
can take out of their properties through a cash-out refinance. They target
groups and areas that promise to have many sub-prime borrowers � lower-income
black neighborhoods, for example. Many occupants of such neighborhoods will be
sub-prime, but those who aren�t and who go along with the soliciting firm will
pay sub-prime prices.
Here are some guidelines to prevent that from
happening to you:
* Never respond favorably to a solicitation
without first checking other options. If you deal with only one loan provider,
your prospects are better if you make your selection by throwing a dart at the
yellow pages than by accepting a solicitation.
* Check your eligibility for mainstream
financing with mainstream lenders. The easiest way to do that is on-line. Some
sites that I like for this purpose are Eloan.com, homemortgagecenter.com,
countrywide.com, mortgage.etrade.com, mortgage.com and Indymac.com.
* If you can�t qualify with any of them,
your best bet is an Upfront Mortgage Broker (they are listed on my web site).
They may charge sub-prime applicants a little more because they require more
time. You will know what they charge, however, and you will know that you are
getting the wholesale price posted by the lender, which means you won�t be
exploited.
Copyright Jack Guttentag 2004
| 
