The frightening return of the subprime mortgage
No, neither Jason, nor Freddie, nor Arnold has returned after having been absolutely, irrevocably annihilated in the last episode.
Rather, it’s subprime, the evil force that terrorized America, from Wall Street to Main Street to Elm Street, that may be coming soon to a closing near you.
A residential mortgage lender has announced that it’s making loans of up to $2 million that don’t require tax returns or employment verifications. Nor does it set a minimum time from a short sale that the borrower might have had. Bankruptcies and foreclosures require only two years’ seasoning after the event. Income is verified through bank statements, and an income-to-debt ratio can be as high as 50 percent.
The loan to value ratio is capped at 85 percent, but no mortgage insurance is mandated. A 700 credit score will qualify a borrower for a $2 million loan, and only 500 is necessary for a mortgage up to $750,000. And, to top it all off, cash-out refis are OK.
Sounds kind of scary, doesn’t it? But maybe the movie doesn’t live up to the trailer. Let’s take the loan product apart and see what it looks like.
First, you can determine a borrower’s disposable cash flow quite accurately by analyzing bank statements. A 50 percent debt-to-income ratio is high, but not much more than the Fannie Mae standard of 43 percent.
The envelope is being pushed at 85 percent loan to value, but it’s probably not an insane bet, given that real estate values are on the rise, and in some markets dramatically so.
A 500 credit score and a forgiving attitude toward bankruptcies, foreclosures and short sales are elevating some eyebrows in banking, but this may be the least liberal of all of this lender’s criteria. There are millions of deserving walking wounded from the Great Meltdown who probably deserve credit but can’t get it with the qualifying guidelines set by the regulations coming in the wake of the Dodd-Frank Act.
Certainly, if you lost your job, and your home was foreclosed, your credit score isn’t going to be blowing in the breeze at an 800 level. But you’ve gotten back on your feet and shouldn’t be disenfranchised from the American Dream, right?
There is some business risk to this program, and the lender is certainly getting paid for it, with interest rates about 2 percent above Fannie Mae and Freddie Mac levels.
But it would seem that there’s a real and significant risk of another kind: regulatory and legal.
Here’s why. The new regulations that have come online in 2014, and this year say that lenders have a so-called “safe harbor” if they make loans underwritten to conforming, i.e., Fannie Mae, guidelines. These loans are called “qualifying mortgages.” If a loan is outside that qualifying mortgage safe harbor it means that a borrower, whose house is in foreclosure, can actually allege that the lender did not adequately assess the borrower’s ability to repay when making the loan, and sue the lender.
If the suit takes place during the first three years of the life of the loan, and the borrower is successful, that borrower can collect from the lender all the interest and fees paid during those three years, plus attorney fees (this last phrase is kind of important). After three years, there’s no cash settlement; the amount is simply offset against the foreclosure.
For a big lender, there has to be a goodly number of these cases before the company is at risk, and the likelihood of that is less in a recovering economy. But those three little words, “plus attorney fees,” really gets the attention of the class action bar.
And then there’s the regulatory risk, which could be considerable. No law or reg says a lender can’t make loans that are not “qualifying mortgages.” But the assumption of the Consumer Financial Protection Bureau, the federal big-dog regulator, is that these loans can be traps to abuse consumers. And no lender wants to spark the attention of the CFPB.
This agency has enormous power. It answers to nobody but Congress, which isn’t exactly the best manager of anything. And the bureau can levy enormous fines, called civil money penalties, on the companies and people who work for these businesses. Just one CFPB audit can pull the plug that can send a lender down the drain.
A lender venturing outside the safe harbor can be like a Methodist missionary taking pictures in North Korea.
You’re definitely being watched.
Pat Dalrymple is a western Colorado native and has spent almost 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is email@example.com.
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