The Subprime woes

The recent problems with the Stock Market remind me of the importance of having good credit. During the mortgage refinance boom of a few years ago, lenders sought various ways to increase their market share. One such method was to attract the individual who up until than, had been ignored, the subprime borrower. Subprime borrower generally could be identified as having certain financial characteristics. These credit qualifications included:

• Late Mortgage Payments. How has the borrower repaid their current mortgage. Usually a subprime borrower has multiple mortgage payments that have been made beyond the thirty day period with a certain period of time. Typically, within the last twenty-four months.
• High debt to income ratios. This would be the relationship between the amount of debt that is being reported on their credit report to the amount of income that that individual produces. Usually, anything over fifty-five percent is considered above industry standards.
  
• High credit balances. Borrowers who typically have credit problems are unable to properly manage their finances. The balances on the loans that they do possess usually are at a higher limit, signaling to the creditor that they may be having trouble making payments.
  

While just a few of the many factors that made up a typical subprime borrower, you get the general idea of the makeup of that particular market. This was a disaster waiting to happen. Mortgage lenders take the loans that they make, package them up and securitize them through selling the loans on the bond market to investors. In the past, only the best loans were used as collateral. During the heyday of the mortgage refinance boom, this practice was ignored. Lenders began to package riskier loans made to riskier borrowers. Adjustable Rate Mortgages or ARMs, as they are popularly known as in the industry were sold on a wide scale. These loans were fixed at a low interest rate for a short period of 24-60 months on average, and afterwards would adjust upwards at an alarming rate for the remainder of the loan! These loans had the potential of raising the borrowers mortgage payment by hundreds of dollars from its original amount.

It did not take much to see how this was paying with fire. Providing mortgage loans to individuals who had previously demonstrated that they were risky for a reason. This house of cards did not take long to begin to crumble. New Century, a mortgage lender who specialized in loans to subprime borrowers, was the first to feel the heat. Its earning reports showed a high number of its borrowers had defaulted on their loans. Other lenders began to experience the same problem as interest rates began to climb. Finally, Countrywide Mortgage, a leader in the industry had finally announced that many of its none subprime borrowers were defaulting! This was a final nail in the coffin of the industry. One of the top lenders in the industry was having problems with its less riskier borrowers! This has resulted in the current state of the stock market.

I wonder how many of these lenders could have avoided this problem had they kept to their own lending practices. Credit scores and qualifications are set to a certain standard for a reason. These lenders would have been wise to stick to their own best practices.