Subprime Lending and Subprime Lenders
Subprime lending is best defined as the act of offering financing to a borrower with blemished credit, low income, or limited documentation, who generally wouldn’t qualify for a mortgage at standard market interest rates. If a borrower fails to meet the requirements of the premiere banks and lending institutions, they must resort to using a subprime lender who in turn will offer higher interest rates.
As a general rule, a borrower with a Fico score of 620 or below would fall into the subprime category, also known as “B paper” or “near-prime”. If a consumer has a Fico score below 620, there is a good chance they have major derogatory accounts in their credit profile, or possibly overextended credit. Typically a 620 score doesn’t just happen, and is usually the result of a collection, charge-off, bankruptcy, or another serious delinquency.
Subprime offerings include programs geared towards borrowers with low income and a high debt-to-income ratio that can’t qualify with traditional lenders, along with high loan-to-values and aggressive lending practices traditional banks find too risky.
Many subprime critics also consider interest-only loans, negative-amortization loans, and generally any non-fixed mortgage to be subprime, although that view is somewhat extreme and more opinion than fact.
So how did the subprime lending industry get its start? As interest rates dropped and mortgage became wildly popular, many potential homeowners sought financing but were turned away from traditional banks and lenders. This created a new, extremely large demographic that was without financing. Enter opportunity.
Proponents of subprime lending realized the demand for homeownership and refinancing despite imperfect credit and jumped on the untapped customer base, offering similar, if not more aggressive mortgage programs at a premium. Subprime lenders were able to find investors to sell the loans on the secondary market, even those with low fico scores and limited documentation, despite the obvious risk. The practice was justified because it allowed borrowers with an imperfect credit history to receive home loan financing, which in theory is said to spur the economy and increase spending and employment rates.
Subprime lenders and secondary investors decided to take on more risk because of rising property values, as the risk was reduced two-fold. First, with rising property values, the borrowers were able to gain equity despite paying less than the fully amortized payment or interest-only payments each month because of perceived appreciation. Secondly, lenders reduced their risk exposure because the rising market provided equity to the homeowners which was enough collateral to refinance the loan to a lower payment option to avoid foreclosure.
Unfortunately this formula was very flawed, and now with home prices stagnant or dropping, we are seeing a flood of mortgage defaults and foreclosures. Now almost all secondary investors have backed out, leaving subprime lenders with no capital and a lot of closed doors.
Subprime lending was never short of critics. Many felt subprime lenders were acting as predatory lenders, offering risky mortgage programs at unreasonable costs, often leaving under-qualified borrowers with huge mortgage debts, placing homeowners into poorly explained loan programs such as option-arms and interest-only home loans. And now these borrowers have little place to go, and few options to avoid foreclosure.
In late 2006 and early 2007, many of the biggest and best subprime lenders have closed shop, including Fremont, New Century, Ameriquest, and many, many more.
I’d add a list of subprime lenders, but there aren’t any left…that said, here is a general list of closed lenders.
