By Jesse Herman, contributing editor
The Mortgage Industry and Investors are keeping a close eye on the Subprime market, hoping it is not an indicator of things to come.
Subprime lending has stepped forward as the new bad guy of the home loan market. To understand why, we need to understand what subprime loans are.
A subprime loan is designed to offer those who would otherwise not qualify for a mortgage an opportunity for home loans and ownership. Many subprime divisions are affiliated with prime loan companies and account for much of the income. They are in disguise, if you will, like an Ebay store for a legitimate online retailer selling to those who could not otherwise afford their products.
The main reason for not qualifying for prime financing is usually due to a low credit score. The entire structure of rates and fees are higher because of extra marketing needed and the greater risk for companies involved with this type of loan.
What is the issue?
Shady mortgage lenders that qualify clients for home ownership who have can't afford it. Targeted are low-income inner-city markets where the majority only qualifies for subprime lending. Some lenders even sell to those who would qualify for prime loans but are unaware through lack of research. The results of these practices are foreclosure and an unstable market.
Those just beginning to rise up the financial ladder can benefit from subprime lending through a mortgage called the 2/28 ARM. This adjustable mortgage rate is fixed for 2 years and then reset to equal the rate index at that time, plus a margin. At the 2 year mark, rates will often rise sharply no matter what the market rates are.
This is wonderful if financial security accumulates in that given time, but terrible if financial prospects have stayed the same or declined.
The premise of subprime lending should make any lender weary of overzealous practices. Unfortunately, the opposite has happened, as many who don't make enough money have been qualified and can't repay financial debts. Mortgage lenders are facing an ignored reality that some borrowers are not responsible enough to own a home.
The old adage "greed is good" has fallen on its face as "tomorrow's problems" have come and the results are being felt right now, with more financial crisis expected to come.
Since December, over 20 subprime lenders have shutdown, scaled back or sold their company.
The U.S. Attorneys office for the Central District of California is conducting a federal inquiry into the trading of securities and accounting errors for New Century Financial, Corp. Analysts have downgraded other companies such as HSBC Holdings, NovaStar Financial and Accredited Home Lenders.
What is the Answer?
Federal regulations and a massive overhaul are going to need to take place in order to stabilize the mortgage industry. Ideally, if a lender approves someone who files for foreclosure, that lender should be penalized.
Restrictions will have to be tightened, thus penalizing those who would have qualified for a loan. Less people will qualify, even those who are financially responsible, making the loan process difficult for those who deserve home ownership.
As always, the best answer for consumers is education. While corrupt lending practices are certainly at fault, so too are borrowers seeking loans they can't afford or accepting loans they are overqualified for.
It does not matter how trusting a broker may seem, always contact 3-4 other lenders before reaching a life-altering financial decision. Living above given monetary means will always catch up in the end, leaving those seeking comfortable standards in financial ruin.
There are many online mortgage calculators available free of charge. Utilize these tools and be prepared for wise mortgage decisions.
