What you ought to know (#6)...

What does "sub-prime" mean and what is going on with these loans?

Subprime loans are mortgage loans made to consumers that don´t meet the underwriting requirements of mainstream lenders, namely those with bad credit ratings or insufficient collateral. In exchange for the higher risk (of late payments, default or foreclosure) that lenders assume in granting such loans a) the interest rates they charge are much higher; and b) other terms written into the agreement may leave borrowers vulnerable to huge payments years down the road.

In a nutshell, the consumer is paying to make up for their poor qualifications or insufficient means, and in exchange, the lender is making a riskier loan.

The trouble begins when other factors come into play that make it difficult, if not impossible, for these consumers to repay their debts. During the housing boom, many subprime buyers took out loans under the best of conditions (between 2001 and 2005) - low interest rates and a booming real estate market.

Many borrowed using adjustable-rate mortgage loans (ARMs), which leave open the prospect of unpredictably higher rates in the future, but often make it easier and cheaper to borrow at the time. And many "predatory lending" companies made a specialty of ARMs and other non-traditional (e.g. income only, payment option) loans that put buyers in properties that they are arguably unqualified to purchase.

Now, those Adjustable Rate Mortgages made back in 2001 through 2005 are adjusting up, and in many cases, making huge jumps in the borrower´s payments. To complicate things, a good percentage of the borrowers were paying the minimum payment option on their loans, not realizing that this created negative amortization (adding on to their principle balance). Combine this with the drop in real estate values that have occurred over the last year, and many borrowers are in an upside down position: owing more than their home is worth. Unable to refinance, and now facing a large increase in their monthly mortgage payment3;foreclosure looms in the future. Luckily for our market, this represents a small portion of the loans that are used to purchase homes ? less than 5%, and typically, the home buyers we see are not sub-prime buyers.

Bottom-line, if your client has questions about the market and what influences it, you should have them talk with Arrowhead Home Loans