January 2008 Topic - The subprime mortgage crisis

01.  Predatory Loans
02.  Subprime loans
03.  Types of Mortgages
04.  Other useful information for mortgage shopping

1.Predatory Loans

In the year 2006 over 1,250,000 homes were foreclosed on. A total of 437,498 filings were reported in the first quarter of 2007. Nationally, 87% of all foreclosures occur on single family dwellings, townhouses and condos. Foreclosures can happen to anyone, regardless of social class, race or type of mortgage.

This newsletter will review the subprime mortgage market, including definitions, types of loans, ramifications of these loans as well as ways to avoid being a victim of predatory lending.

In most cases subprime mortgages are for borrowers with credit scores under 620. Credit scores range from 300 to 900, with most people falling in between 600 to 700. When consumers are late in paying their bills, especially when falling behind 30, 60, or 90 days past due, the consumers' credit score will suffer. When it falls below 620 the consumer will be in subprime lending territory. Most lenders will not use the term sub-prime to describe a loan to a consumer; instead they refer to these loans as nonprime as to not concern the borrower.

Those lucky enough to not be considered subprime borrowers receive rates that do not vary from lender to lender for similar loans. This is not so for those who fall into the subprime category. These borrowers can receive very different offers based on the way the lender weighs the individual risk. For this reason, if you have a credit score less than 620 it's imperative that you compare rates of different lenders before locking into a mortgage.

2. Subprime loans

Subprime loans have higher rates than prime loans. The process mortgage lenders use to determine mortgage rates and terms is called "risk based pricing". As there are many factors that are considered when deciding on mortgage rates and terms, it is difficult to generalize subprime rates. They are obviously higher, but the actual rate depends on many factors. These factors include credit score, down payment, as well as previous delinquencies. As far as delinquencies go, late mortgage or rent payments are frowned upon more so than late credit card payments.

Most subprime loans include prepayment penalties, balloon payments, or both. A pre-payment penalty is a fee assessed to the mortgage holder for paying off the loan early, this will be assessed because the house was sold or refinanced the high rate loan. A balloon payment requires the mortgage holder to pay off the entire outstanding balance in a lump sum after an allotted amount of time has passed, usually five years. If the borrower cannot make the balloon payment he/she must refinance the loan or sell the house.

When shopping for a mortgage, borrowers must be on the lookout for predatory lenders who are out to take advantage of subprime candidates. Predatory lenders use a variety of tactics for this purpose. Some lenders hit naive borrowers with exuberant fees along with exceptionally high interest rates. In many cases these lenders will have the borrower believe his/her credit score is lower than it really is.

Another tactic predatory lenders use is to have homeowners refinance mortgages frequently, charging high closing fees and hiding additional closing costs in the back end of the mortgage. This tactic goes along with another common predatory tactic where a lender will issue a mortgage knowing that the holder does not have the ability to repay it. When the loan falls into default the lender forecloses and resells the property. A predatory lender makes money by constantly collecting fees and foreclosing on property.

3. Types of Mortgages

There are all different types of mortgages. However the most common mortgages are fixed or ARM. A fixed mortgage comes in different terms. The most common terms for fixed mortgages are 15 year or 30 year. A fixed rate mortgage is guaranteeing you that the interest rate will never change throughout your term regardless of the market. An ARM, which stands for adjustable rate mortgage, fluctuates with the market. The interest rate will vary depending on the current market. There are advantages and disadvantages to each of these different options of mortgages.

Adjustable Rate Mortgage Pros	Adjustable Rate Mortgage Cons
Lower payments in the beginning. You will be able to afford a bigger house.	Rates adjust with market therefore you can end up with a very high interest rate.
Will be able to take advantage of lower rates without having to refinance.	ARMS tend to be very complicated and difficult to understand. You could end up getting trapped into something you were not aware of.
Since payments are lower you will have extra money to invest or save	The initial fixed rate is so low that often the rate after will be increasingly high.
A good idea for people who intend on only owning home for short period of time.	In some cases buyers can actually end up owing more money than they did at closing.

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Fixed Rate Mortgage Pros	Fixed Rate Mortgage Cons
Your payment and rate will remain the same regardless of the market.	If rates drop lower than your mortgage you will need to refinance in order to take advantage of fallen rates.
Budgeting is easier due to the fact that your payments remain the same every month.	Monthly payments cost more than other mortgages.
Very simple and easy to understand.	Cannot be customized from lender to lender.
There is an end in sight. You will know when your loan will be paid in full.	Not a good idea if you plan to move soon.

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More Mortgage Options
Jumbo Mortgage	A Jumbo Mortgage is a nonconforming loan. You can borrow more money but you pay a higher interest rate.
Balloon Mortgage	Low rates for a specific amount of time but then you need to pay off loan or refinance.
Assumable Mortgage	You can give your loan to the new buyer of your home. These loans are very rare.
Construction Mortgage	This loan is used for people building homes. They pay higher interest rates while home is being built and then it is usually turned into a fixed rate structure.
Seller Financing	An agreement where the seller finances the home for the buyer. The seller makes monthly payments to the seller verse a lender.

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4. Other useful information for mortgage shopping

The advantages to putting money down on your home include, not needing to finance 100% of it, therefore you will not pay interest on that money. Also sellers usually consider people putting down money more secure buyers. The more money you put down the less your monthly mortgage payment will be.

The number one disadvantage is tying up your cash. Many people like to have a comfortable savings account when buying a home therefore they do not want to use all their cash as a down payment.

Discount points are an optional fee that you pay to your lender to reduce your interest rate on your mortgage. A point is equal to one percent of your loan amount.

A conforming loan goes by the guidelines set by Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are two mortgage companies that buy mortgages from lenders. They will only take loans up to a certain limit. The current limit is $252,700. A nonconforming loan does not abide by the guidelines set by Fannie Mae and Freddie Mac.

Mortgage Banks: A direct lender. Your mortgage bank is regulated by state and federal agencies. You will deal directly with the source of your loan, which in turn may save you money throughout the process. Your loan will most likely get processed quicker when dealing with a mortgage bank. The disadvantage is they will only offer their own programs. You will want to compare rates and programs before choosing to go through them.

Mortgage Brokers: Acts as a middleman. A mortgage broker will try to get you the best loan for your specific needs. A broker will be able to get you in the right direction depending on your personal financial situation. You will also save time shopping for loans and will get a competitive rate. The disadvantages are hidden costs. You must be very careful that you are not getting charged too much for a service since they are not always regulated by the state and federal agencies.

In conclusion buying a home will be one of the most important decisions a person can make in his/her lifetime. Hopefully I was able to shed some light on the process as well as provide cautionary advice regarding subprime and predatory lending. It is always best to do as much research as possible before making such an important purchase that can have ramifications for years to come.

On a personal note United Financial would like to wish everyone a happy healthy new year. This year we would like your input as to what topics you would like for our monthly newsletters. Please email us your suggestions to .

Got a question? Then contact our Education Team on 561-883-2398 Ex.310 United conducts regular seminars on financial education, including "How to Budget", come along and join us. To reserve your seat contact our Education Team on 561-883-2398 Ex.310

Newsletter 01
Rev.1
January, 2008