As the mortgage industry evaluates all sectors of mortgage lending, there is a serious question as to the future of nonprime lending. Contrary to much public opinion, a viable market for nonprime borrowers should exist.
Well, at least for certain nonprime borrowers.
And though the industry might not be ready for the new nonprime marketplace quite yet, it is never too early to start a dialogue about this important market segment.
While there will be an undeniable tendency to paint all nonprime loans and borrowers with the same broad strokes, the reality of nonprime lending is that all nonprime is not created equal. There are many more dimensions to nonprime products, nonprime borrowers and nonprime lending that need to be explored.
Truth be told, despite less-than-favorable market conditions and the current credit crisis, nonprime borrowers actually exist who represent acceptable credit risks and viable homeowners. And to best determine whether nonprime lending should be available at all, it is first important to distinguish that two types of nonprime borrowers exist.
Let's look at two fictional borrowers to explore the distinct types of nonprime consumers. Jim is 30 years old and has always had a difficult time maintaining good credit. His credit card payments are frequently late, his student loans are past due and he is often delinquent on his rent. In addition, he has a poor work history and does not currently have a full-time job. As a result, Jim has a credit score of 550.
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John, also 30, has a credit score of 550. However, he suffered a severe personal credit crisis last year due to a car accident. Prior to the incident, John had excellent credit, paying all his bills on time. Unfortunately, the car accident caused John to miss work and resulted in thousands of dollars in medical bills. During this time, his ability to make certain payments suffered, and he fell behind on credit cards, car payments and rent.
John, now fully recovered, is working full-time again and has reestablished good credit on his revolving and installment debt. Nevertheless, his credit score remains 550. Should we evaluate Jim and John the same way when it comes to mortgage qualification?
The answer, of course, is no. Jim has neither the ability nor the willingness to repay a debt, while John has both the ability and willingness to repay.
Simply put, there are ‘good’ nonprime borrowers who may have a blemished credit history, yet simply reviewing their credit score does not tell the whole story. People with good credit who fall subject to a work-related injury, divorce, illness or other special circumstance sometimes experience damaged credit.
However, once the special circumstances are resolved, the borrower generally returns to a history of on-time repayment. Unavoidable incidences with a specific time period are no reason to rule out a borrower who is potentially a good candidate for mortgage financing. In mortgage lending, a viable subprime mortgage market should exist for these ‘good’ subprime borrowers.
In other words, sometimes bad things happen to good people. And when these bad things happen, they should not necessarily disqualify a good person from attaining a mortgage.
Now that we recognize that a viable nonprime mortgage market should exist for certain nonprime borrowers, it is necessary to identify who will establish a new nonprime marketplace. Â
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Today's scene
The Federal Housing Administration (FHA) has taken a leadership role in approaching borrowers with less-than-perfect credit but who exhibit an ability and willingness to repay their mortgage loans. However, a private sector market for nonprime loans will eventually be necessary. This option would benefit the previously described good nonprime borrowers who actually have a good job or a savings account, and who can also document what caused the bad credit and that it has been resolved.
The last necessary element for a viable, future nonprime marketplace is the development of safe and secure nonprime mortgage loans.
What, exactly, are the characteristics of a good nonprime loan? First, they almost always carry a higher interest rate than prime loans. Additionally, prudent underwriting practices dictate that nonprime loans should not have any risk-layering across multiple loan characteristics, such as acknowledging a low credit score, requiring no down payment and lacking documentation of income or assets.
On the other hand, for a borrower with less-than-perfect credit who can make a down payment, document the income and assets, and provide documented evidence of the reason for poor credit and that the circumstance has been eliminated, risk is not layered.
A good nonprime loan is possible – it just needs to make sense. Good nonprime loans should require a down payment, document the borrower's income and assets, and not have significant payment adjustments during the life of the loan. Most importantly, they should never be predatory in nature.
While there are good and bad subprime borrowers, there are also good and bad subprime lenders. Borrowers classified as nonprime can be fragile, and providing them with dangerous loan products substantially increases the likelihood of a loan default.
It is imperative that future nonprime mortgage loans be fairly priced and prudently offered to each individual borrower. The loan needs to reflect the borrower's financial situation and maintain a fair price given the assessed risk.
The key is to create subprime products that project the likelihood of success instead of the likelihood of failure.
Unfortunately, a plethora of bad loans and equally as many bad borrowers over the past several years have created a devastating credit crunch in both the nonprime and prime markets.
Acknowledging that the market is not quite ready to embrace a new nonprime marketplace at this time, it must be recognized that allowing nonprime loan products to exist is not only sensible, but also necessary.
A viable mortgage marketplace for prime and nonprime borrowers will eventually emerge to provide homeownership opportunities for borrowers of all shapes, sizes and credit scores.
Scott Stern is CEO of Lenders One, St. Louis. He can be reached at sstern@lendersone.com.
