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   ARTICLE   |   From Scotsman Guide Residential Edition   |   April 2004

The Right Time For Sub-Prime

It’s early 2004, and the well of A-paper refinances is running dry. The number of layoffs by mortgage lenders is rising in tandem with rates. One A-paper source, when asked what he was going to do now, responded, “It’s time for a hobby.”

But not all lenders are downsizing. Not all borrowers are sitting contented on their existing interest rate. There’s a market out there that’s not only relatively insensitive to rate fluctuations but also growing every year. It’s the best kept secret in the mortgage industry: the sub-prime market is booming. If you’re currently only dealing with A-paper, you’re dead—but I’m going to bring you back to life with a roadmap to identify, market, and package loans to sub-prime borrowers.

Why Rate Matters Less

Historically, the sub-prime market has proven to be less vulnerable to shifts in interest rate cycles because consumers with financial issues continue to look for financing alternatives regardless of rates. To understand why this is so, it helps to understand who sub-prime borrowers are—and what they aren’t. They’re not credit pariahs, deadbeats, or people trying to take advantage of the system for personal gain. The National Home Equity Mortgage Association (NHEMA) tells us that they are, on average, 48 years old with a mean income of just over $55,000.

Statistically speaking, they could be your neighbors. Of 10 families on your street, three to five of them are likely to be sub-prime borrowers. Think of individuals in households near yours who might fit the profile: middle-class, own a home, drive nice cars, and seem to have plenty of spending money. But they may have lost a job, had a major medical expense, been in an accident, or be planning to put a child or two through college. They’re people with whom you chat, attend church, or associate on a business level. They’re people you see every day—though you never suspect that their personal finances lie in ruins.

In my experience, sub-prime borrowers are victims of circumstance who are unable to protect themselves from that circumstance. They have house payments, car payments, and credit card payments—but, because of their circumstances, can’t make their payments for a month or two or more. Most sub-prime loans, reports NHEMA, are taken to consolidate high-interest debt or to finance a child’s college education. You should note that these are not rate-sensitive issues.                                        

Why Sub-Prime Is Growing

The sub-prime market is growing—and if you don’t know a sub-prime borrower now, chances are you soon will—because Americans are using more and more credit. Our consumer debt now totals more than $2 trillion, according to the Federal Reserve; it has more than doubled since 1994.

Personal bankruptcies are also growing: 7.8% to a record 1.63 million bankruptcies in Fiscal Year 2003, states the Administrative Office of the U.S. Courts. As a society, we’re going more into debt and becoming increasingly unable to pay it off! This trend isn’t going to reverse itself, at least not any time soon.

When customers with high debt load or a bankruptcy on their record want to consolidate debt or get cash, the fact of getting the loan is usually more important than half a percentage point on the interest rate. Rate isn’t entirely unimportant—no one wants to pay an exorbitant rate, after all. But sub-prime borrowers know they have credit issues, and they want a rate that is fair, competitive, and associated with the risk that their credit represents.

Next Steps

Once you’ve decided that a mix of prime and sub-prime customers will help you through the roller-coaster ride of changing rates, the next step is to find those customers. It’s extremely important to understand how to approach, market, sell to, and package sub-prime borrowers because simply applying the approach you take to your A-paper borrowers won’t work. The sub-prime market requires a different search and a different appeal.

Next month I’ll discuss how to find sub-prime customers and how to market to them within a wide variety of media. Future articles will cover the sub-prime approach and sales pitch, getting the sub-prime package right, and developing technology for a growing market. Each article will deliver all the instructions you need to fill your well of loans with eager and creditworthy borrowers—all the information you need to find success in the sub-prime arena.

The opinions expressed in this article are those of Greg Schroeder, not those of New Century Mortgage Corporation.


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