subprime loans back like in 2007?
Let’s talk about 4 things about Subprime loans in 2023. It does feel like the subprime loans are coming back in May of 2023. I received a few new loan programs from local lenders. They call it “down payment assistance” or “closing cost assistance” programs. I’m learning about the programs to help some home buyers who might benefit from using these.
I couldn’t help comparing it to the subprime loans that were popular in the mid 2000’s before the market crash. So, I’ll explain my thought process here:
What is a subprime loan?
Subprime loans are higher risk loans given to borrowers with:
- Below 620-640 according to FICO (Fair Isaac Corporation) credit score
- Below 660 according to Federal Deposit Insurance Corp (FDIC)
- The score standard varies depending on websites… which is a bit odd.
To make more loan programs available to borrowers who may not be qualified with traditional conventional loan qualifications.
- Experienced a judgement, foreclosure, bankruptcy…
- Carries higher rates and fees than prime loans
- Higher rates to compensate for the lenders for taking greater risk of borrower’s defaulting
- Interest-only, fixed and variable rate programs
- Variable rate subprime loan payment can increase significantly over time
- Aka, expensive loan to borrow for financially weak borrowers (poor credit scores and issues on their credit reports)
I personally used the subprime interest-only loan as a home buyer in 2005 when I bought my first house in Portland, Oregon. I didn’t have a job at the time and I still scratch my head how I was able to get a loan without a job. It was called, “Stated income” loan. You tell the lender how much you made the last two years, and they believe you without verifying the information. As far as I know, those stated loans don’t exist in 2023.
why new loans are similar to subprime loans?
Some of the details of these new programs that are coming up resembles the mid-2000’s subprime loans.
- 101.5% LTV (Loan-To-Value Ratio) lending
- Available to poor credit score borrowers: 620 credit score may be qualified for downpayment/closing cost assistance programs
- Not requiring downpayment
If a borrower is financially strong, but somehow hasn’t saved the funds for downpayment and closing costs, programs like these can bridge the gap and allow the borrower to purchase a home sooner than later. However, 620 credit score indicates that the borrower may not be financially strong indirectly. So is this a smart choice for the borrowers?
What could go wrong?
Here are some scenarios where things could go wrong for borrowers:
- Borrowing more than they can afford
- Potential of dealing with rate hikes in the future if they get adjustable rate loans
- If housing market crashes 10-20% after these programs being used too widely in the next 2-4 years
- If variable subprime loan becomes unaffordable to borrowers and home price declines, the demand would slow down and we might see more foreclosures. Possibly no options to refinance or sell without paying out of pocket to make up the difference (aka short sale)
What you should do
If you are utilizing one of these down payment assistance and/or closing cost assistance loan programs:
- Make sure to understand the fee and extra costs of the loans
- How they might affect your monthly payment for now and in the future
- Avoid the Variable Rate loans to protect against potential future rate hikes
- Stay within your budget: buying a property you can truly afford and moving to lower priced cities
Make sure to understand your financial situation by educating yourself before jumping into a homeownership with programs like these. There’s no free lunch.