Subprime loans are back — with a new name

These mortgages, aimed at low-credit-score borrowers, are marketed as 'nonprime' loans.

By MSN Real Estate partner Feb 6, 2014 12:30PM

© Andrea Bricco/Brand X Pictures/Getty ImagesBy Kathleen M. Howley, Bloomberg 


Bill Dallas, whose last two subprime lenders went bust during the global credit crunch, pledges to get it right this time around.


Dallas, 58, plans to offer the loans through his new company, NewLeaf Lending in Calabasas, Calif., this year. He's one of a growing number of executives striving to resuscitate the market, which six years ago crippled the global economy, with a revamped subprime product.


Gone are the days when lenders handed out mortgages without requiring documentation and down payments. Today's purveyors of subprime call the loans "nonprime" and require as much as 30 percent down to safeguard their investment. And they see a big opportunity for growth as tougher federal lending standards shut out millions of Americans with poor credit from the mortgage market.


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"You're going to have to make all types of loans, ones that conform to all the new standards and ones that don't, to keep powering the housing recovery," said Dallas, chief executive officer of Skyline Financial Corp. in Calabasas. "There needs to be a solution for people who don't fit in the box, and rebuilding nonprime lending is it."


The current level of subprime lending is a trickle compared with the flood that helped spur the housing boom. The loans are made to the riskiest borrowers, with low credit scores, high levels of debt and inconsistent income.

About $3 billion of subprime mortgages were made in the first nine months of 2013, matching the year-earlier period, according to Inside Mortgage Finance, a trade journal. In 2005, subprime originations reached $625 billion.


Investor challenge

"We've done enough loans to prove to us that it's a product we're going to continue to grow," said Brian O'Shaughnessy, head of Athas Capital Group in Calabasas, which began making subprime loans nine months ago. "The biggest thing that has held us back is that a lot of brokers don't know the product is back."

Investors are taking a pass on subprime for now. Lenders have to either hold onto their loans or sell them to private equity firms until they establish a strong enough track record to offer mortgage-backed securities to investors. That leaves the Federal Housing Administration and Ginnie Mae, which packages Federal Housing Administration subprime loans into bonds, as the main sources of help to the riskiest borrowers.


"I don't think the face of subprime should be Ginnie Mae," said Dallas, who earned a degree from the Santa Clara University School of Law and has three decades of experience in the mortgage business. "The challenge is rebuilding an investor base. A lot of them are still deciding what risk they will take to get the higher yield."


Subprime bust

During the loose lending era — driven by Wall Street's demand for subprime loans to securitize — firms invented and pushed a bevy of high-risk products. There was the so-called exploding ARM, a mortgage with an interest rate that could triple after two years. Bankers assumed the loan would be refinanced before the adjustment as long as home prices kept rising. Eventually, they didn't.

Bankers also peddled NINA products (no income, no assets), and "liar" loans — mortgages based on the applicant's unproven income. Most of these loans went to subprime borrowers — or those with credit scores below 660, according to the Federal Reserve definition.


As home prices began plunging, the wave of subprime defaults was severe enough to help topple Bears Stearns Cos. and Lehman Brothers Holdings Inc. in 2008. Skyline's Dallas experienced the destruction caused by run-away subprime lending up close.


Federal rules

He had taken over subprime lender Ownit Mortgage Solutions Inc. and had founded First Franklin Financial Corp. After Dallas sold it, Franklin became the nation's fifth-largest subprime lender and Merrill Lynch & Co. bought the company for $1.3 billion in 2006. Both Ownit and Franklin were washed away along with more than 100 subprime lenders during the financial crisis.

Federal regulators banned many of these high-risk mortgages and lenders began demanding higher credit scores from borrowers. The average score for a mortgage approved by Fannie Mae in 2012 was 761 compared with 713 in 2000.


In January, the Consumer Financial Protection Bureau raised the lending bar even higher. The bureau's new Qualified Mortgage regulations provide a measure of legal protection to lenders who meet guidelines. And the rules expose them to legal liabilities if their loans fail certain tests, like charging high fees or requiring payments that, when combined with other debts, exceed 43 percent of the borrower's income.


30 percent down 

The stiffer rules have shut out a big chunk of borrowers with credit scores below 660 — about a third of Americans — from the mortgage market. New subprime lenders are pursuing these borrowers with mortgages that carve a middle ground: While the loans often don't meet CFPB's rules, they do require documentation of income and large down payments that discourage defaults and mitigate losses.

Athas Capital offers mortgages at an interest rate of 9.75 percent for borrowers with a credit score of 550 to 599 and who can put 30 percent down, O'Shaughnessy said. He said all borrowers have been on time with their payments so far.


"The word subprime in a lot of people's minds is dirty, but the product today is much different, much safer," O'Shaughnessy said. "You can have credit transgressions, but you're coming up with a big down payment and you have to back up what you say on the application."


Marilyn Monroe

The revival will help American families who want to go from being renters to owning their homes, William Erbey, CEO of mortgage servicer Ocwen Financial Corp., said last month at an investor conference. The share of homes purchased by first-time buyers fell to 28 percent in November, according to the National Association of Realtors. During the decade ending in 2012, the average monthly rate was 40 percent.

Erbey said Ocwen Financial will begin issuing subprime loans at a future date, without giving specifics on timing.


"Tighter underwriting standards have created a significant imbalance between supply and demand," said Erbey, whose firm is based in Atlanta. "I use the analogy — why didn't a million men date Marilyn Monroe? There was not a lack of demand. There was a lack of supply."


Irvine, Calif.-based Citadel Servicing Corp., which began subprime lending seven months ago, gave Roberto Balcker a chance to own a home. Balcker, a real estate agent, wasn't able to qualify for a loan backed by Fannie Mae or Freddie Mac because his commission income fluctuates too much.


First-time buyer

"We're giving people an opportunity to purchase property they wouldn't qualify for if their only option was the government," said Dan Perl, CEO of Citadel Servicing, which isn't related to Citadel LLC, a Chicago investment firm.

Citadel issued Balcker an 8.75 percent adjustable-rate loan to buy a $130,000 condo in Miami's Edgewater neighborhood last month. The rate, which is fixed for the first seven years, could go as high as 14.75 percent, according to Miami-Dade County records.


"If it wasn't for this type of lending, I would still be a renter," said Balcker, 38. "I make twice the income of clients of mine who found conventional financing, but I couldn't qualify for a mortgage."


Subprime isn't dangerous if the lending is done prudently, said Frank Pallotta, managing partner at Loan Value Group, a firm in Rumson, N.J., that advises mortgage investors on risk.


"It's a slippery slope if you start to get back to the products we saw in 2005 and 2006," Pallotta said. "Any skimping on documentation and any mortgages with big rate adjustments down the road are just defaults waiting to happen."


Slippery slope

The bundling of subprime mortgages into securities to sell to investors won't be viable for a few years, said Sonny Weng, a mortgage analyst at Moody's Investor Services in New York. Investors won't buy subprime bonds unless the mortgages have low loan-to-value — a comparison of the mortgage balance to the worth of the home — and borrowers have proven their income, Weng said.

"Right now, investors don't have much appetite for subprime because they got burned during the crisis," Weng said. "Longer term, you may see further development of this type of product. Investors looking for higher yields may become interested."


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Tags: loans
Feb 8, 2014 11:39AM
To Concerned Veteran I appreciate your service to our country. However, you need to look at more recent history to Bill "I love a good cigar" Clinton's presidency. That is when the Glass Steagall Act of 1933 was repealed. Fast forward to the 2000's and George Bush's presidency. There were several attempts to get congress to  "rein in" Freddie and Fannie. It was the government agency with oversight of investment banks that allowed investments banks to loan 40 dollars for every dollar they held rather than the 10 to 1 normally allowed. This was to try and keep the "house of cards" from falling because congress did not act despite attempts to past bills one of which was proposed by John McCain and one or two others. Let's not forget the CRA set up under President Carter and put on steroids under Clinton as part of the first bailout of banks in late 80's early 90's. Banks were required to make loans available that would not otherwise be available. Government loans were and are available for people who do not have substantial down payments. What was left but bad credit, no doc loans, etc. Was there greed on Wall Street ?Absolutely!  Were improperly rated derivatives part of the problem? Absolutely!  But folks the bigger and biggest problem is the government that did not and does not properly monitor and enforce the regulations they have in place. Politicians who care about getting elected rather than governing and who rarely if ever pay for their mistakes...blame it on Wall Street...blame it on the wicked rich.  When you have idiots like Barnie Frank the Chairman of the House Banking Committee at the time of and well prior to the financial collapse that stated over and over that "there is no problem and that everyone should be able to own a home." "There is no problem, but if there is we'll bale it out."  When you have a poorly written law like Dodd Frank that creates a lot of problems and expense for smaller local banks and have a provision designed to keep bank influence from the  appraisal process that do not properly keep big bank ownership out of the process. When you have the federal government institute poorly constructed bailout to save Main Street (i.e. individuals under water) rather than Wall Street you have a system that enriches the Big Banks and investment houses that does very little to help those individuals it is "designed to help," wastes tax dollars, and in the case of HAMP kicks the can down the road.  Sub prime loans have been around for years and by themselves are not and were not the problem. When greed and lack of realization that real estate prices will not climb upward for ever; not just by Wall Street but by Fannie and Freddie as well there will be problems.  We need to learn by past mistakes and put the blame where it mostly belong on an incompetent and inefficient federal government.  We need to hold our government responsible period!! 
Feb 8, 2014 11:07AM
The solution is to require the lender who makes the loan to service it until it is paid off. No selling discounted paper to some gullible dupe. You make it you live with it. What happened last time was that a lot of lenders made bad loads based on fraudulent appraisals and inadequate buyer vetting . Because they knew they would pass it on to someone else before the bubble burst they did not care.
Feb 8, 2014 11:04AM

Now called "Obama's No Hope for Change Unsupported Mortgage".
Feb 8, 2014 10:26AM
I went through the VA. 0% down & no PMI required. 20 years of military service has a few bennies left.
Feb 8, 2014 10:08AM

No real regulations on Wall Street to separate the commercial banks from Wall Street. These sub prime loans will blow up in our face again. Why does Wall Street and the big banks think they can keep doing the same thing over and over again and get a different result. The to big to fail is 5 times bigger, are we going to bail them out again?

ARM's, Balloon's and anything other than traditional loans should be illegal, they will just sell this junk to Wall Street and here we go again...

Reinstate Glass Steagall and make these type loans illegal.

Feb 8, 2014 10:01AM
30% down subprime loan is more risky than a 0% down VA or 3.5% down FHA loan.  Really???
Feb 8, 2014 9:23AM
It is surprising just how uninformed and ignorant the above posters.  If anyone can remember history it was under Teflon Ron's administration that all the regulations were removed concerning Banks, Walls Street, etc.  The ones to blame are neither the Republicans or Democrats it is BOTH parties.  It was a SPLIT house house and senate when all of the regulations were removed back in 1987.  That was also the year the IRS tax rates were DRASTICALLY lowered for those making more than $175,000/yr; it went from 50% to 28%.  All of this can be verified by looking thru and checking the tax rates.
Feb 8, 2014 8:53AM
If you can afford a 30% down; you should take that opportunity to pay off outstanding loans, raise your credit score and get a mortgage at a decent interest rate. This nonprime BS sounds like snake oil salesmanship to me.
Feb 8, 2014 8:33AM
Just bought my first house via non-prime loan, last week.  Anything beats renting.
Feb 8, 2014 8:13AM
This is the kind, considerate way of telling those that shouldn't buy a house that their credit reeks.  Oh yeah, and the politicians - they're all for that because those poor bastards are up for re-election this fall. You have to get the idiots attention that your taking care of them to get their vote!  Think I'll go over and have a talk with Ms. Chokesondick if this qualifies as an equivelant of her last name.
Feb 8, 2014 8:10AM
Yep, lets just change the name to something that can't be identified with the last economic downturn.  As far as I'm concerned, both of these names spell ****. Anything else attached to the "Prime" will fit into that category and not be worth the effort to read about or invest in.
Feb 8, 2014 8:01AM
Sounds like a bunch of bulls**t to me. 

Fool me once shame on you, fool me twice shame on me.   
Feb 8, 2014 7:55AM
Why not just call it what it is, Loan Sharking?
Feb 8, 2014 7:31AM

MIKE, Clinton was talking about new people have the earning power to afford their own homes and that is a good thing.  You are twisting the context to fit your POV.

The truth is that both parties had a hand in the crash, in different ways, for different reasons, too many to all list, but a couple of smash hits:

1) GOP supported outsourcing with corporate tax breaks + wanted to break unions = lose of income

2) DEMs supported FHA lending that helped new aka riskier buyers to own homes + wanted to win the worker vote and the recent immigrant vote = looser D/P standards

3) Reagan and other pro-free-market conservatives radically deregulated banking + pushed away from local banking toward national and international banking = loss of community responsibility in banking

4) GOP in congress pushed for repeal of the Glass-Steagall Act (which was first passed by Dems and FDR after the '29 crash caused by the GOP).  The congressional Dems try to block it, but Clinton ( a social liberal but a fiscal conservative) signs it anyway = greatly loosened lending and investment bank guidelines. In all of Congress, only six Republicans opposed it, as the GOP had drafted and sponsored the bill.  The vote, pulled from a NYT news report on the day after it passed, was as follows, "...One Republican Senator, Richard C. Shelby of Alabama, voted against the legislation. He was joined by seven Democrats: Barbara Boxer of California, Richard H. Bryan of Nevada, Russell D. Feingold of Wisconsin, Tom Harkin of Iowa, Barbara A. Mikulski of Maryland, Mr. Dorgan and Mr. Wellstone.

"In the House, 155 Democrats and 207 Republicans voted for the measure, while 51 Democrats, 5 Republicans and 1 independent opposed it. Fifteen members did not vote." 

5) Bush announces in December 2000 that the U.S. is in a recession.  It was not, but he spooks the highly leveraged Dot Com investment market, which begins to unravel.  He is sworn in a month later.  The recession begins in September 2001 + Bush wanted to make it look like he inherited a recession, which he did not + Republicans tend to favor status quo industries (auto, fossil fuels, defense, mining, utility, banking) of emerging industries(new technology, internet, alternative energy) and adopt policies to favor those preferences + Republicans tend to prefer vulture investment markets...(read remainder under Mike West's post)

Feb 8, 2014 7:28AM

the housing market did'nt crash because of people who are poor buying houses. the main reason was the securities were sold a triple a and they were far from it. had moodys and other listed the securities for what they were, they would not have sold nearly as well and there would not have been the capital to fuel the overload. also no doc loans and too high debt to income as well as too high interest.

 i do subprime auto loans everyday. i require 30% down, verfiy every doc and chage a high enough interest to make u for those who don't pay and auto's are much riskier than houses since they depreciate. if you stay within reason on debt to income, get a solid down payment and charge a higher but fixed rate of interest then they will perform just fine.  

Feb 8, 2014 7:06AM
This meets the definition of insanity, which is; Doing the same thing over and over and expecting a different result. It is the lawgivers that are allowing/pushing this new recipe for disaster so the poor can enjoy the American dream of home ownership.  Does that sound familiar?!?
Feb 8, 2014 6:37AM
A turd by another name still stinks
Feb 8, 2014 6:28AM

By the way, if you all want to see a fantastic movie about this topic, Margin Call is a masterpiece. And what a cast! 

You can't be a dummy and follow the plot, i suppose.  It may help to read up.  For instance, they never say, "mortgage-backed securities."  They say, "MBSs."

They don't name an investment bank, but it looks like they are telling the Goldman-Sachs story.

My wife checked it out from our library.
Feb 8, 2014 6:17AM
As a taxpayer I just hope that this time when this goes bust, and it will go bust, I am not left picking up the pieces so these guys don't have to take responsibility for their decisions. If you can't save at least 10% of the cost of the house as a down payment and you can't show a consistent earning history then you are not a good credit risk.
Feb 8, 2014 6:10AM

Some qualifying and a down payment. How quaint!


If only Chris Dodd and Barney Frank had thought of this common sense approach instead of meddling with the CRA, which led to reduced mortgage buying standards, which led to the economic collapse that Bush inherited.

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