Subprime Lending is Making its Way Back to the Mortgage Market

An uptick in housing demand is being met with mortgage originations for borrowers with less than perfect credit scores, but not without caution.

Equifax's National Consumer Credit Trends Report, which provides population-level debt and lending insights from more than 210 million consumers, found that from January to October 2015, first mortgage originations for subprime borrowers, or those with an Equifax Risk Score of 620 or less, have increased significantly since crisis-times.

For the first 10 months of 2015, new mortgage origination volume totaled 312,000, bringing the value of these loans to $50.7 billion. This represents an increase of 28 percent in number of first mortgage originations and a 45 percent increase in the total balances compared to last year.

Equifax Chief Economist Amy Crews Cutts told MReport that although subprime mortgages are rising, lenders are not originating loans without considering if the borrower will be able to repay the loan.

"There is no lender who will do a loan that doesn’t carefully consider the ability to the borrower to carry the debt," Cutts stated. "Adjustable-rate loans are still around, but they no longer feature the negative amortization feature and interest-only loans are rare. Moreover the capacity underwriting is at the fully amortizing payment and at the maximum rate rather than the teaser rate. One can get a low down payment loan, but the money must come at least in part from borrower assets, not another mortgage loan."

She continued, "While there are many characteristics that define a subprime loan, such as the specific terms of the loan and the lender who issues it, credit standards are becoming more accommodating to meet market demand. At the same time, lenders are focusing more attention on evaluating consumers' ability to repay. This has led to a much larger reliance on third-party data verifications that enable lenders to more accurately vet subprime borrowers much earlier in the origination process."

The home equity market also experienced an increase in subprime lending, Equifax noted. Subprime home equity installment loans value rose 32.7 percent year-over-year to over $1.4 billion in 2015, while the total credit limits on home equity lines of credit (HELOCS) rose 6.8 percent to a value of $608 billion in 2015.

"Home equity installment loans are often more suitable for consumers with credit issues, but the regulatory costs and underwriting burdens have typically made them very expensive for lenders to originate," Cutts explained. "Conversely, HELOCs are generally more popular among consumers, but less accessible to subprime borrowers. Mortgage insurance is a viable alternative for home equity loans that might be used as piggy-back financing for part of the down payment on the first mortgage and may explain why we are not seeing similar proportionate increases in subprime home equity loans."

Fortunately, if subprime lending continues in the mortgage market, there are provisions in place to prevent substandard loan underwriting.

"The unregulated Wild-West atmosphere that came to dominate mortgage lending is long gone. Consumer protections are in place to ensure that borrowers only get approved for mortgages that they can reasonably afford, new licensing requirements exist for mortgage brokers, credit risk cannot be off-loaded onto investors unless the loan meets the Qualified Mortgage requirements, and many other changes affect the lending landscape today," Cutts noted. "It’s not to say that another financial crisis couldn’t erupt at a future time but the current environment is not conducive to speculative investing and reckless lending like we saw prior to 2008."

Cutts concluded, "Subprime loans fulfill an important niche in our lending markets–whether enabling a refinance that might allow a family to keep the home they have or allowing a family that is finally seeing brighter days reach their dream of homeownership. They are the second-chance loans, but not all borrowers with credit problems should be homeowners at this moment, and good subprime underwriting, like good prime-credit underwriting, should have ensure that borrowers have a high chance of success."

Click here to view the full report.