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   ARTICLE   |   From Scotsman Guide Residential Edition   |   October 2005

Nonprime Finds Its Time

Previously reserved for borrowers with low credit scores, nonprime loans are coming into their own as homeowners change

r_2005-10_Anderson_spotLife happens. Jobs are lost. Marriages end. Kids go to college. Roofs leak. Health issues set in. Neighbors buy nicer cars, triggering the “keeping up with the Joneses” effect. And the list goes on.

Life circumstances such as these have changed U.S. homeowners and subsequently have blurred the line between what constitutes a prime and a nonprime borrower.

Then and now

In the 1980s, when usury controls were eliminated and interest rates increased, nonprime loans initially were made available to borrowers with tarnished credit histories that provoked higher credit risk. Categorizing a nonprime borrower essentially was a black-and-white issue; the decision was based on a simple look at a person’s credit rating.

Fast-forward 20 years, and the issue has become gray. Although nonprime loans still accommodate borrowers with less-than-perfect credit scores, more are issued to hard-working, responsible folks who simply fall outside the proverbial box of Fannie Mae and Freddie Mac conforming guidelines.

Today’s nonconforming borrower usually carries a respectable FICO score, generally between 620 and 640. In fact, according to the Coalition for Fair and Affordable Lending, the average nonprime borrower had a 638 FICO score in 2004, which was an increase from 637 in 2003. Being unable to document or verify income or having an unfortunate life situation such as a divorce or unemployment, however, has created a threat of debt liability for these borrowers. It has prompted the need for special financing.

Additionally, many nonprime borrowers simply want to cash out more equity from their homes than traditional prime lenders will allow. The standard Fannie or Freddie cash-out allowance is 90 percent. But often, borrowers need more cash than that to pay for college tuition, medical bills or necessary home remodels or repairs.

Nonprime borrowers also can fall into the “fake it till you make it” category. These people pay their bills on time but are maxed out beyond their means. One setback in any given month for these borrowers would have prime lenders looking the other way.

Nonprime goes mainstream

Simply put, borrowers can no longer rely solely on good credit history to lock in a prime loan. Consequently, nonprime borrowers can no longer be packaged into one definition.

For various reasons, more than 30 percent of Americans cannot qualify for a prime loan, according to the Coalition for Fair and Affordable Lending. The U.S. Census Bureau also reported that the U.S. homeownership rate for the second quarter of 2005 was 68.6 percent, up about 1 percentage point from five years ago and about four percentage points since 1995. Much of that growth is attributed to the availability of nonconforming-loan provisions.

Former Federal Reserve Board Gov. Edward Gramlich recently said the nonprime market had been growing at a rate of about 27 percent a year, representing $530 billion, or 19 percent, of the mortgage loan market in 2004 versus just 5 percent 10 years ago.

Now, nonprime is suddenly mainstream and moving even closer to prime-time territory. Naturally, nonprime loans are still priced higher than prime loans because of the inherent increase of risk and service levels involved, in addition to associated compliance costs. Whereas the spread between prime and nonprime loans was around four points just five years ago, today that margin has shrunk to just two points.

Other factors to consider

The burgeoning blurring line between prime and nonprime loans causes a bit of confusion for some mortgage brokers. However, keep in mind that although the profile of the American borrower has changed, two fundamental lending criteria have not — loan to value (LTV) and collateral.

Lenders have a deluge of data at their fingertips that allow them to determine the risk associated with a loan. Beyond credit scores, past bankruptcies and debt-to-income ratios, lenders surreptitiously scrutinize LTV and collateral to evaluate what it will potentially cost them if the loan were to go belly up.

This means that you as a mortgage broker have an increased need to become an advocate for your borrowers. It is your job to provide your borrowers with all the options (including checking for prime-loan-product eligibility, if applicable) that will allow them to make the best long-term decisions for their financial futures. After all, if you don’t have your borrowers’ trust and confidence, you don’t have any loans from which to draw commissions that will fill your coffers.

The mortgage industry as a whole has had its good reputation siphoned by the missteps of a few ill-advised or ill-intentioned brokers. It is important to police yourself to restore a solid reputation. It is your fiduciary responsibility to work with others to ensure that every loan is the best fit for each respective borrower.

•  •  •

The development and evolution of nonprime loans, for credit-challenged and nonconforming borrowers alike, have brought the American dream of homeownership to a segment of the population that otherwise might have been denied its piece of the pie.

With the availability of nonprime options, more borrowers not only have the opportunity of homeownership but also an opportunity to build wealth and economic security — nice things to have in a back pocket.


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