Being a mortgage banker , I’ve done my fair share of researching the impact of the current “Mortgage Meltdown”, but what I haven’t seen publicly written is one very dirty little secret about the way most subprime mortgages were structured. So I’ve come to share. Hats off to Chris Iverson of the Ventoux Real Estate Group, by the way, for doing a superb job on his Mortgage Mania series.
I will never forget the first subprime mortgage solution that I originated. It was about three years ago, the mirror was officially fogged by the client, and the terms looked something like this:
–first mortgage for $400,000 at 80% loan-to-value, 30-year period, fixed for two years at 8.00%, interest-only payments allowed, 2% discount fee, with a three-year prepayment penalty at six months interest
–second mortgage for $100,000 at 20% loan-to-value, 15-year term, fixed for 15 years at 12%, amortized payments, 1% discount fee, no prepayment penalty
What a minute, a mortgage fixed for two years, but the prepayment penalty lasts for three years? Wait another minute, don’t the payments on that first mortgage double in the third year? Yes and yes.
I wasn’t aware that the first mortgage had a prepayment penalty beyond the fixed-rate period until the final loan documents were prepared. As you may imagine, after reading the documents I made an immediate phonecall to the lender that I had brokered the deal to (oh, and yes, that company is BK) and re-negotiated the prepayment penalty to two years without any additional cost.
The truth is, as I further investigated subprime lending, I discoverd that most of those loans were structured that way, and most were not re-negotiated…
So if borrowers were essentially set up for failure, doesn’t that have a domino effect to the lender that issued the paper and the investor that bought that paper? Yes. And that’s why we’re here today. That’s also why we originated as few of these loans as practical.
The reality was that modern subprime lending (modern in that it used to be called “hard money” and the loan-to value requirements were 65%-70% of property value) actually seemed like a win:win in the beginning. Think about it for a moment. To those who were willing to buy, but had serious financial difficulties, subprime lending was a great financing vehicle to own the American Dream or maybe begin investing in real estate . To the investor, it was a low-risk, secured investment that would earn a hefty 11+% yield. Oooops, maybe it wasn’t so obvious a win:win.
We can blame whomever we wish for the current mortgage mess: the rating agencies, Wall Street, big banks, small banks, mortgage banks, mortgage brokers, real estate professionals, borrowers, etc. My feeling is that all of the above share in the blame since it allowed all parties to get greedy. And might we all agree that greed can be a very dangerous motivation?
Tags: , Investing, Mortgages, Real estate
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1 A Dirty Little Secret About Subprime Mortgages | ImmediateRealEstate.com // Jan 22, 2008 at 4:25 am
[...] unknown article is brought to you using rss feeds.Here you will find the latest real estate news for buying and selling homes.To those who were willing to buy, but had serious financial difficulties, subprime lending was a great financing vehicle to own the American Dream or maybe begin investing in real estate . To the investor, it was a low-risk, … [...]
2 Lending News » Blog Archive » A Dirty Little Secret About Subprime Mortgages // Feb 11, 2008 at 6:27 pm
[...] Rod Williams wrote an interesting post today onHere’s a quick excerptThe reality was that modern subprime lending (modern in that it used to be called “hard money” and the loan-to value requirements were 65%-70% of property value) actually seemed like a win:win in the beginning. … [...]
3 Anonymous // Feb 13, 2008 at 3:42 pm
I had 100 % equity but no FICO score. Sub prime @ 11 %. Argued pre payment to 1 yr. Now trying to refi, still have 40 % equity and over 20 % of value of home in a money amrket. Income verifcation IS a problem. I have a professional license and that seems to help. The market will come back and it actually is a great time to buy.
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