Sub-Prime Loans Gone, so now what?

The sub-prime market has just about disappeared. What happened to these types of lenders? And where will real estate lending be in the future?

Sub-Prime Loans were set up for Borrowers who didn’t necessarily qualify for Conventional type loans. Loans typically had higher rates. The rates depended on the rating of credit and it was also dependant on the property being purchased, especially whether it was an owner occupied or investment property and Loan-to-Value.

1980

The Depository Institutions Deregulation and Money Control Act in 1980 made the sub-prime business legal by allowing higher rates and fees that lenders could charge the borrower.

1982

The Alternative Mortgage Transaction Parity Act allowed variable interest rates and balloon payments.

Wall Street then began to securitize the sub-prime mortgages.

Thousands of mortgages were bundled together and then could be sold, which created a secondary market. Conventional loans had Fannie Mae and Freddie Mac for a secondary market, so this was key to the explosion of sub-prime financing. Most sub-prime financing was through private investors and with a secondary market created, demand shot up in the 1990’s.

With increased demand, though, came more relaxed guidelines. Properties were mortgaged sometimes over 100% LTVs (sometimes using a combination of a 1^st and 2^nd leins on the property), or loans were set up on adjustable rates or maybe the borrowers had an okay LTV at the time, but had shaky credit and/or a questionable ability to repay. There were even loans that were called “stated income” or “low/no-doc” that did not verify income or other assets at all.

Wikepedia summarizes the impending crisis like this: “The crisis, which has its roots in the closing years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in financial industry regulation and the global financial system. Approximately 80% of U.S. mortgages issued in recent years to subprime borrowers were adjustabable-rate mortgages. After U.S. house prices peaked in mid-2006 and began their steep decline thereafter, refinancing became more difficult. As adjustable-rate mortgages began to reset at higher rates, mortgage delinquencies soared." Securities backed with subprime mortgages, widely held by financial firms, lost their value. The result has been a large decline in the capital of many banks and U.S. government sponsored enterprises, tightening credit around the world.

Many blame the sub-prime crisis for the current economic situation. It’s been a combination of events, though, having a domino effect. With all the foreclosures and jobless numbers increasing, banks were tightening lending, real estate prices have fallen, stocks have been volatile and an array of other economic factors factored into the recessionary times.

As the economy recovers, lending practices have and will continue to change. Banks have tightened up on conventional lending and appraisal methods and it has made it harder to get conventional financing. As a private money lender, we are seeing a lot of good loans that didn’t fit the parameters of a conventional loan that now come to us for alternative financing. Our private money investors, though, typically lend on short-term and rates are higher. It works, though, for some who need that bridge loan, construction or re-hab loan. But, for others there is no longer that middle ground and it may take a long time before banks can or will ease up on lending standards.