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Subprime lending beginning to return in Charlotte

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  • What is subprime lending?

    Subprime lending continues in the wake of the financial crisis. But lenders say it is not the reckless subprime lending that took place before the housing collapse.

    Generally, subprime, or non-prime, loans are those given to borrowers with poor credit scores and shaky credit histories. Such loans have higher interest rates than prime loans because lenders assume there’s a higher risk they will default.

    During the housing collapse, subprime loans with certain risky features, such as prepayment penalties and balloon payments, were rampant. Borrowers, many receiving loans to refinance their mortgages, were able to get loans with little to no documentation of income or assets. When those borrowers went into default, they helped trigger a recession that began in December 2007.

    Today, subprime loans have fewer risky features than before the downturn. Under federal rules that took effect this year, borrowers must provide lenders with documentation of income and other financial information to show they can repay. New federal rules also ban prepayment penalties and generally ban balloon payments.

    Some lenders remain reluctant to lend to subprime borrowers, even as others ease restrictions. Deon Roberts



Subprime mortgages, often associated with the run-up to the financial crisis, are making a comeback in Charlotte.

No one is predicting a return to the risky lending that was rampant during the housing boom. But a growing number of lenders are accepting homebuyers with lower credit scores as they relax the strict requirements they’ve placed on borrowers since the crisis.

“I would say it’s very prevalent,” said John Smith, a Charlotte loan officer for Movement Mortgage. “My personal feeling is the subprime market is coming back in baby steps.”

Under a widely accepted definition, subprime borrowers have a credit score of below 620. Many lenders have steered clear of borrowers with low credit scores after defaults on subprime mortgages helped spark the recession in 2007. Now, some lenders are tiptoeing back into subprime as home prices rise and mortgage lending appears poised to decline this year, with fewer borrowers refinancing.

A sampling of what’s happening in the Charlotte market:

• Home-lending giant Wells Fargo this year dropped its credit score for home-purchase loans backed by the Federal Housing Administration from 640 to 600. The reduced score applies only to loans the bank originates, not loans it acquires from so-called correspondent lenders.

• Smaller lenders in Charlotte are also lowering their minimum credit scores for government-backed loans. Some lenders say they are accepting borrowers with scores as low as 500.

• New subprime players are popping up. Deephaven Mortgage, launched last year in Charlotte, is purchasing “responsible non-prime” home loans from lenders, according to the company’s website.

Even as they loosen requirements, lenders are quick to say that these are not the same kind of subprime loans that fueled the crisis.

Before the housing collapse, subprime lending exploded in an era when borrowers could still get a mortgage simply by stating their income and providing no documentation. Federal rules that took effect this year require lenders to use eight factors to verify that borrowers are able to repay.

Lenders also say subprime borrowers can expect high levels of scrutiny as lenders try to figure out why their credit scores are so low. It is likely that many subprime borrowers will end up not qualifying for a loan, as parts of their credit histories disqualify them, some lenders say.

But others are casting a wary eye to the lowering of credit score minimums after the subprime implosion triggered the worst economic downturn since the Great Depression and led to billions of dollars in government bailouts.

“I have mixed feelings that more people can obtain credit to purchase a home and the fear that it could lead to disastrous subprime lending,” said Peter Skillern, executive director of Reinvestment Partners, a Durham organization that has been critical of predatory lending practices. “There’s always an element out there who wants to push the boundaries. That’s neither good for the consumer or the market.”

Easing ‘overlays’

After the financial crisis, mortgage lenders tightened their requirements – in part they feared being forced to repurchase loans that defaulted.

Lenders introduced “overlays” – guidelines that went beyond the standard requirements for mortgages backed by the government or bought by government-controlled mortgage giants Fannie Mae and Freddie Mac.

They’re now relaxing those overlays, as they drop credit score minimums largely for FHA and other loans backed by the government. Conventional loans, which are those purchased by Fannie Mae and Freddie Mac, will still generally require a minimum score of 620, they say.

Credit scores range from 300 to 850 under the widely used Fair Isaac Corp., or FICO, system. Subprime borrowers face higher interest rates the lower their credit scores are. They also could be asked to make a larger down payment or have a large amount of money in reserves to cover as many as six months of mortgage payments.

Lenders say easing their credit score overlays will benefit borrowers whose scores were low because of a one-time setback, such as a divorce.

“The pendulum had swung too far. Now we’re just trying to find that equilibrium,” said Phil Mahoney, president and CEO of Charlotte-based American Security Mortgage, which late last year dropped its minimum credit score from 640 to 600 for a government-backed loan.

Movement Mortgate’s Smith said his company decided late last year to start considering FHA applicants with credit scores below 640. In the Charlotte area, the company is making mortgages for “good, qualified borrowers” with scores as low as 600, he said.

A spokeswoman for Bank of America said there are cases where the bank might make an FHA purchase mortgage for a person with a credit score “in the lower 600 range.”

The willingness to accept borrowers with lower credit scores comes at a time of subdued lending for the mortgage industry. U.S. lenders are forecast to make $1.1 trillion in purchase and refinance mortgages this year, a decline of 37 percent from 2013, according to the Mortgage Bankers Association. While purchase mortgages are expected to be higher than last year, it will not be enough to offset the expected decline in refinance activity from rising mortgage rates.

Open to more risk

Keith Luedeman, CEO of Charlotte-based lender Goodmortgage.com, said declining refinance volume is part of what’s driving lenders’ loosening of underwriting standards. More significant factors are rising home prices and other encouraging signs, he said.

“The primary driver is the improving economy,” he said. “This point in the business cycle is when banks feel more comfortable taking more risk, whether it’s lower scores on mortgage loans or more aggressive business and commercial lending.”

Lenders are not seeking a return to the freewheeling lending practices that fed the subprime boom, he said.

“It’s responsible, a little more risky lending,” he said. “Responsible subprime lending is a really good thing for the economy because people can buy homes that previously could not buy homes, which means more homebuilding, more jobs, accelerating the improvement in the economy.”

A new player in Charlotte is helping fuel subprime’s return.

Deephaven Mortgage is buying loans that largely fall outside the federal government’s new qualified-mortgage guidelines. The company plans to buy loans made to borrowers with credit scores as low as 500 from lenders across the country, said founder Matt Nichols, a former managing director in New York for Goldman Sachs. Goodmortgage.com is among Charlotte companies in discussions to do business with Deephaven.

“We’re looking to help lenders serve folks that have had a credit event or housing event but have good income and assets and we think the ability to afford a mortgage,” said Nichols, who moved to Charlotte in 2012.

‘Very troubling’

Reinvestment Partners’ Skillern said lending to someone with a credit score of 500 is “very troubling.”

“That’s too low,” he said. “You can’t make a loan to someone with a 500 credit score and also call it responsible.”

Not every lender in Charlotte is lowering credit score minimums into subprime territory, said Janet Gaglione, president of the Charlotte Regional Mortgage Lenders Association.

“Some companies are willing to take the risk, and some are not,” she said. “I guess it remains to be seen who survives the risk they’re willing to take.”

Roberts: 704-358-5248; Twitter: @DeonERoberts
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