Subprime Mortgage Requirements and How They Affect You

Bills.com co-CEO available to address subprime lending crisis

SAN MATEO, Calif., July 11, 2007 - Protecting consumers is a noble goal, says Andrew Housser, co-founder and co-CEO of online consumer portal Bills.com (www.bills.com) -- but Americans now face the risk that protection could go too far, which in turn could restrict credit so that some consumers would be unable to borrow or own a home. The Federal Reserve held public hearings last month that resulted in new requirements for government-funded lenders. The new rules are intended to curb subprime lending practices some say are abusive. But activists now are pushing Congress to enact legislation that would further restrict subprime lending. Subprime loans are offered at a rate higher than prime to borrowers who have less-than-ideal credit. Lenders charge this higher rate to make up for the added risk of lending to poor-credit borrowers. The higher interest rate can result in thousands of dollars in additional interest over the life of the loan, but it makes homeownership a possibility for some borrowers who otherwise would not qualify for a mortgage. According to the Mortgage Bankers Association, nearly 16 percent of homeowners with subprime ARMs were 30 days or more past due on their payments in the first quarter of 2007 -- an all-time high. The new regulations passed in late June require federally funded lenders to verify borrowers' incomes in most cases, provide clear information about mortgage terms and allow borrowers 60 days without penalty to refinance a loan that is about to reset. "It is a delicate balance between regulation to prevent abusive practices and over-regulation, which actually decreases access to credit, decreases consumer options, and ultimately hurts the people that legislation is trying to help," Housser said. "If regulation is poorly designed, it can work against consumers and their ability to buy a home. Lenders will not bother lending money to consumers if they think it will be too hard to make a profit. The fact is that lenders need to charge risky borrowers higher interest rates to compensate for that increased risk." Some of the most dangerous practices in the subprime lending industry are:

  • Stated-income loans: An industry term for these loans says it all: "liars’ loans." The subprime industry has used stated-income loans to let buyers obtain any mortgage they request by stating (not proving) their income. Usually, borrowers state an income level that allows them to obtain the mortgage they want -- without regard to actual income. The result: The borrower’s income may be insufficient to pay the mortgage.
  • Sketchy debt-to-income ratios: The finance industry long has held that mortgage payments should be no more than 28 percent of total income, and the total of all debt payments should fall below 35 percent of income. Some lenders have pushed those ratios, allowing borrowers to obtain mortgages that push ratios as high as 50 percent. The result: Payments far beyond affordable, which in turn result in more loan failures.
  • Loans that reset: According to the Center for Responsible Lending, more than three-fourths of subprime loans issued during a recent period were adjustable-rate mortgages (ARMs). More than 90 percent of those ARMs will jump to a sharply higher interest rate after several years. The result: Payments and defaults jump, too.
  • Prepayment penalties: Many subprime loans examined in the recent hearings included prepayment penalties. With this provision, homeowners must pay a penalty (often thousands of dollars) if they pay off their loans early. The result: If a homeowner needs or wants to sell or refinance the home, she or he risks all the equity, and more, as a penalty for ending the mortgage.
  • No-escrow loans: These loans allow for lower monthly payments by excluding payments to an escrow account for homeowners insurance and property taxes. The result: Homeowners are shocked to realize they don't have money to pay the significant bills for homeowners insurance and property taxes that arrive once or twice a year.

"Adjustable rate mortgages, low teaser rates, and interest-only mortgages have served to trap some consumers who bought houses they otherwise would not be able to afford. They either did not understand how their payment could increase over time, or were overly optimistic about their future income potential," Housser said. "I do not believe it is the government’s role to make financial choices for consumers, but they can make sure that consumers at least understand the choices that they are making," he added. "As this issue moves under pressure toward Congress, we may see legislation that forces mortgage brokers to go through budget analyses with their clients, and forces clearer disclosure of how adjustable mortgage payments could change over time. However, the fundamental problem of American consumerism cannot be cured by legislation: People want to acquire more today and worry about paying for it later." To arrange an interview with Andrew Housser, please contact Aimee Bennett at (303) 843-9840 or aimee@faganbusinesscommunications.com. Based in San Mateo, Calif., Bills.com is a free one-stop online portal where consumers can educate themselves about complex personal finance issues and comparison shop for products and services including credit cards, debt relief assistance, insurance, mortgages and other loans. The company blogs about consumer finance issues at http://www.bills.com/. Since 2002, Bills.com and its partner company, Freedom Financial Network, have served more than 15,000 customers nationwide while managing more than $350 million in consumer debt. The company's co-founders and CEOs, Andrew Housser and Brad Stroh, were named Northern California finalists in Ernst & Young's 2006 Entrepreneur of the Year Awards.