Michele and Russell Poland's credit was shot, but they managed to buy their suburban dream home anyway.
After a business bankruptcy and a home foreclosure, they turned to a rare option in this era of tightfisted banking — a subprime loan.
The Polands paid nearly $10,000 in upfront fees for the privilege of securing a mortgage at 10.9% interest. And they had to raid their retirement account for a 35% down payment.
Most borrowers would balk at such stiff terms. But with prices rising, the Polands wanted to snag a four-bedroom home in Temecula near top-rated schools for their 5-year-old son. By later this year, they figure, they'll be able to refinance into a standard loan.
"The mortgage is a bridge loan," said Russ Poland, now working as an insurance investigator. "It was expensive, but we think it's worth it."
In the aftermath of the housing crash, there's no shortage of Americans who, like the Polands, are eager to rebuild their shattered finances. In response, lenders are emerging to offer the classic subprime trade-off: high-priced loans for high-risk customers.
Before the housing bust, a sprawling business arose in subprime mortgages and their cousins, so-called alt-A loans, which were issued to people who had decent credit but did not have to prove income. About $1 trillion in subprime and alt-A loans were originated in 2005 and again in 2006 — more than a third of all home loans, according to the trade publication Inside Mortgage Finance.
But the explosion of mortgage defaults that began in late 2006 vaporized an entire industry of subprime specialists. The Wall Street firms that had bundled the loans into securities soon began to implode as well. Little wonder that loans for the credit-challenged disappeared.
Today's high-risk lenders differ from those during the housing boom in key ways. These lenders say the new subprime mortgages are actually old school — the kind of loans made in the 1980s and 1990s. In other words, a borrower's collateral matters, down payments matter, income and ability to pay matter.
Subprime lenders care because they are holding the loans on their books rather than selling them to investors. They hope a private securities market for subprime loans, also destroyed in the meltdown, will reemerge soon.
For now, the subprime and alt-A business remains small, maybe $8 billion total, estimated Inside Mortgage Finance Editor Guy D. Cecala. That's less than half of 1% of the $1.8 trillion in U.S. home loans last year.
Among those hoping to reverse the trend is the Polands' lender, Citadel Servicing Corp. of Orange County. Chief Executive Daniel L. Perl said he has tested the water by making a few dozen subprime loans since late 2011, mostly with his own money rather than investment capital.
The Polands, among the first to receive Citadel loans, are part of a success story, Perl said. None of the loans has gone bad; about a third have already been paid off. With that track record, Perl recently raised $200 million from private investors. He's hiring 55 employees to help him make loans through mortgage brokers across most of the West, and he's moving from Citadel's Aliso Viejo location to larger offices in Irvine.
"We're looking to build it up over the next 24 months to $30 million to $50 million a month," Perl said. "It's a decent business plan in a credit-barren world."
But lenders such as Perl are proceeding far more carefully than during the housing bubble. Then, borrowers commonly avoided down payments entirely in "piggyback" arrangements that allowed one loan of 80%, another for 20%. Some lenders offered "Ninja" loans — requiring no proof of income, assets or even a job.
Perl now requires 25% to 40% down, depending on credit scores that can drop as low as 500 on an 850-point scale. His potential customers, who pay a minimum of 7.95% interest, include higher-income as well as lower-income borrowers.
"Quite a few" affluent borrowers are good credit risks, Perl said, even though they had recent short sales — they sold homes for less than they owed on their mortgages. Perl also writes mortgages that exceed the
Fannie Mae and
Freddie Mac threshold for conventional loans, which varies but tops out at $625,500 in the most expensive areas.
"They come from all walks of life — doctors and lawyers as well as blue-collar workers," Perl said. "As long as they have the ability to pay and equity in their homes, they are a candidate for one of our loans."
Another lender getting into subprime mortgages is Carrington Mortgage Holdings of Aliso Viejo, a manager of distressed loans and properties that has become a major landlord.
"There are a lot of borrowers who can make a big down payment, document that they have the income to pay the loan and have a good recent job history — but have a credit score that would make it impossible to get a loan," Carrington Executive Vice President Rick Sharga said.
Carrington would like to start making subprime mortgages later this year, depending on the still-evolving regulatory environment for mortgages. Sharga anticipates "a lot of pent-up demand."
In a related development,
Consumer Financial Protection Bureau Director
Richard Cordray last month encouraged credit unions, which often hold fixed-rate mortgages on their books, to make "responsible" loans that fall outside the bureau's general guidelines for responsible mortgage lending. Bureau rules discourage most lenders from writing mortgages that increase total debt payments to more than 43% of a borrower's income. Credit unions are given more leeway in exceeding that baseline, provided they properly vet applicants and charge no more than 3.5 percentage points above the going mortgage interest rate.
"The current mortgage market is so tight that lenders are leaving good money on the table by not lending to low-risk applicants seeking to take advantage of the current favorable interest rate climate," Cordray told a credit-union trade association. "This actually creates a window of opportunity for credit unions that helped 'write the book,' so to speak, on what it means to underwrite responsibly."
John C. Williams, president of the
Federal Reserve Bank of San Francisco, sees no reason that subprime mortgage bonds can't reemerge in "plain vanilla" form, as opposed to the complex concoctions that ended up as "toxic assets" in the meltdown.
"I can't understand why it hasn't come back sooner," he said, pointing out that there's a strong market for bonds backed by subprime auto and credit-card loans.
"California has been famous for devising exotic mortgages," Williams said. "But the reality is that they held up rather well until we started doing things like giving them to people with no jobs."
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