One participant during a recent online discussion asked me a question that some might dismiss as naive. But it was a question that many people should have asked before they bought their homes. After all, in a recent survey commissioned by bankrate.com, 34 percent of homeowners with mortgages didn’t have a clue as to what type of loan they had.

“There have been many stories in the news about subprime loans,” the reader wrote. “What exactly is a subprime loan? And what exactly is the problem with defaulting on a subprime loan versus a prime loan? Are there signs to watch out for when you are discussing mortgages with a bank or a lender?”

You need to know that there are three lending worlds out there. One world is for borrowers who are ready for prime time loans — they easily qualify for a lender’s best interest rates. Depending on the lender, scores in the low 700s and above put you in prime territory.

In the current interest rate environment, if you’re a creditworthy customer also known as a “prime” borrower, you should qualify for a mortgage interest rate that is less than the prime rate, which is currently 8.25 percent.

In the middle is not-so-prime-time lending — or the “Alternative-A” mortgage world. These loans are made to people who are considered less risky than a subprime borrower but aren’t as creditworthy as someone in the prime category. Alt-A borrowers, as they are also called, can have high credit scores but may not be able to verify their income. Generally, the rate these borrowers pay is lower than a subprime loan. This sector is also having payment trouble.

The furthest from the prime world is the subprime market. Subprime loans are typically made to borrowers who have spotty credit records. The interest rates on these loans are usually at the prime rate or higher.

Subprime loans include nontraditional products with terms allowing borrowers to pay interest only or offering adjustable rates that are subject to sudden spikes after a certain time.

Generally you enter subprime territory when you have a credit score in the low 600s. Each lender sets its own benchmark for subprime customers.

One lender may set the bar at a credit score of 650 or below, another might set the bar at 620.

But a low credit score isn’t the only factor that may push you into a subprime loan. You might only qualify for such a loan if you have a low downpayment or you can’t accurately document your income.

In the case of home loans, the subprime borrowers you’re hearing about these days are defaulting because market conditions have made their mortgages more expensive. Many people with adjustable-rate loans have seen their rates jump as other short-term interest rates have risen, pushing up their monthly payments. Others took out loans with teaser rates hoping they could refinance into better loans. When they couldn’t because their income fell or their home’s value declined, they got stuck with mortgage payments they couldn’t afford.

By the end of the year, as many as 2 million subprime borrowers could lose their homes to foreclosure, according to the Center for Responsible Lending, a nonprofit, nonpartisan research and policy organization.

There is no difference between defaulting on a subprime loan and a prime loan. Although the news has focused on subprime borrowers, even homeowners with favorable mortgage terms are having trouble. The delinquency rate for all major types of loans — prime, subprime, FHA, and VA — increased in the fourth quarter of 2006, as did the foreclosure rate, according to the Mortgage Bankers Association.

The last question — what to watch out for in a mortgage loan — is one all borrowers should be asking. The Center for Responsible Lending, which has been highly critical of subprime lenders, lists some of the things to look for and avoid in a mortgage loan:

-  Excessive fees. Don’t be so quick to get a home loan that you ignore the fees. Mortgage lenders often disguise or play down fees because they are often rolled into a loan.

-  Prepayment penalty. A mortgage with a prepayment penalty option requires you to pay a penalty or fee if all or most of loan amount is repaid within a certain time period (generally ranging from two to five years from the start of the loan).

-  Loan flipping. Despite the rise in foreclosures, the offers to refinance are still plentiful.

But crunch the numbers. Some refinance deals generate lots of fee income to the lender but provide little financial relief to the borrower.

Like this chat participant, I wonder how many people reading all the news stories couldn’t really explain the current subprime mortgage meltdown. It’s certainly true that many prime and subprime borrowers who are facing foreclosure didn’t understand the language and terms in the loans they got.

Found here.

Turmoil in the mortgage market is ensnaring more companies who lend to people with decent credit.

The spread of home lending woes beyond loans to those with weak credit threatens to reduce the availability of loans for some consumers and even threaten the existence of some lenders.

Rising delinquencies and defaults among subprime borrowers — those with blemished credit histories — have resulted in more than two dozen lenders going out of business, moving into bankruptcy protection or putting themselves up for sale.

Now the so-called Alternative-A mortgage sector, which loans to borrowers with better credit than subprime borrowers but not quite prime, is starting to hurt.

One Alt-A lender, American Home Mortgage Investment Corp. of Melville, N.Y., announced late last week that it was having trouble selling its mortgages into the secondary market and would have to cut its earnings forecast for the quarter and the year. At least five analysts downgraded the stock on Monday, and its shares fell more than 15 percent on the New York Stock Exchange. The shares dropped $2.37, or 11 percent, on Tuesday to close at $19.55.

Fulton Financial Corp., which owns two Lehigh Valley area banks, also is feeling pain from its Alt-A lending.

The Lancaster company said last month it expects to take a $5.5-million charge from buying back Alt-A mortgages issued by a bank it owns in Virginia. The bank is being forced to repurchase loans it usually sells because borrowers are falling behind on payments.

Fulton has not reported loan problems at its Valley-area banks, Lafayette Ambassador Bank of Easton and Skylands Community Bank of Warren County, N.J. Fulton owns 13 community banks in the mid-Atlantic region.

Other Alt-A lenders that have taken hits in the market in recent days are First Horizon National Corp. of Memphis, Tenn., which some analysts predict may be forced to sell out to a bigger bank, and M&T Bank Corp. in Buffalo, N.Y.

Guy Cecala, publisher of Inside Mortgage Finance Publications in Bethesda, Md., said a ”backlash” from the subprime market meltdown is part of the equation.

”While you’re starting to see some deterioration of the quality, it’s not so much that investors should be dumping [mortgage-backed securities],” he said. ”But nobody wants to own a security that goes down in value, whether because of public perception or the reality of the market.”

Doug Duncan, chief economist for the Mortgage Bankers Association in Washington, D.C., said that Alt-A mortgages made up a small share of the U.S. market at about 6 percent of outstanding loans. Loans to prime customers, who are the most creditworthy, make up 74 percent; those to subprime borrowers are about 11 percent, and government-backed loans total about 9 percent.

Alt-A borrowers traditionally had credit scores as high as prime borrowers, but often provided less documentation of their finances; in recent years, however, some Alt-A borrowers have had credit scores closer to subprime borrowers and still weren’t asked for full documentation.

Duncan said he expected to see some increase in delinquencies and defaults in the Alt-A market this year, but said the bigger problem was that investors appeared less willing to invest in these loans because of the deepening subprime problems.

That will be a factor in slowing mortgage origination this year to an estimated $2.2 trillion from a peak of $3.9 trillion in 2003 and $2.5 trillion last year, Duncan said.

In fact, The delinquency and default rate for Alt-A mortgages has been considerably less than for subprime mortgages, according to First American Loan Performance, a research firm based in San Francisco that looks at mortgage loans packaged into securities and sold to investors.

The First American data shows that January payments were 60 days late on 14.3 percent of subprime loans, up from 8.4 percent a year earlier. The late-payment figures for Alt-A loans was 2.6 percent in January, up from 1.3 percent a year earlier.

Still, companies that write the Alt-A mortgages are finding that investors are less willing to buy securities that are backed by mortgages — or are demanding significantly higher returns.

Among the biggest Alt-A lenders in 2006 were IndyMac Bancorp Inc. of Pasadena, Calif; Countrywide Financial Corp. of Calabasas, Calif.; Residential Capital, or ResCap, of Minneapolis, a holding company for the residential mortgage operations of General Motors; EMC Mortgage Corp. in Irving, Texas, a subsidiary of The Bear Stearns Cos.; and Washington Mutual Inc. of Seattle.

Glenn Costello, a managing director with the Fitch Ratings agency in New York, said that some of the Alt-A lenders were trying to distinguish themselves from others, arguing that they were worth investors’ continued attention because they had lower delinquencies and fewer problems.

”But the fact remains that for some of the riskier products they originate, there’s a lack of demand for them” as investors get pickier about the market, he said. ”Investors just aren’t willing to pay what they used to.”

Found here.

The subprime mortgage industry is a sizeable chunk of the entire industry. Consumer groups, economists, mortgage bankers, politicians and the Federal Reserve Chairman have given their view on what many are calling the crisis of rising foreclosures associated with subprime mortgage lending. And those views vary as to the effect on the housing industry and the economy as a whole.

What is subprime mortgage lending?

Individuals with a poor credit history have a hard time qualifying for a favorable home loan such as one that a local bank might underwrite. Subprime mortgage lending, then, is the practice of making home loans to these individuals. This form of mortgage lending grew in the 1990s. Subprime borrowers might have a credit history stained by numerous late fees, writeoffs or bankrupties, or they might have a very short credit history. Borrowers who have a high debt-to-income ratio are also likely to be grouped into this category.

Subprime mortgage loans are made for both first-time home buyers and homeowners who want to refinance. These loans include adjustable rate mortgages, no-money-down mortgages and interest-only mortgages. In interest-only mortages, payments begin low and then skyrocket at a later date.

To lenders, subprime borrowers pose a higher level of credit risk than individuals with good credit; that is, there is a greater chance they will not pay back the loan. To make up for the increased rate of default, subprime lenders impose higher interest rates and fees.

According to the Federal Reserve Bank of San Francisco, an increase in access to the capital markets through loan securitization also contributed to growth in subprime lending in the 1990s. Securitization is the repackaging, pooling and reselling of loans to investors as securities.

Critics of subprime mortgage lending argue that lenders trick borrowers into taking out home loans they cannot possibly pay back. Proponents maintain the loans open the door to homeownership to individuals who normally would be unable to buy a home.

Over 2 million people with subprime mortgages are in danger of losing their homes this year, according to the Center for Responsible Lending, a nonpartisan research and policy group. The center also predicts that 1 out of 5 subprime mortgages granted between 2005 and 2006 will fail. These foreclosures are expected to cost Americans about $164 billion in lost equity from 1998 through 2006.

The Mortgage Banker’s Association, a Washington-based group that represents the real estate financing industry, takes issue with the center’s assessment. A recent MBA report states that the CRL’s “pessimistic” account ignores the fact that 85 to 90 percent of subprime borrowers do not default on their loans.

John Robbins, chairman of the MBA, testified March 27 before the U.S. House of Representatives’ Financial Services Committee Subcommittee on Financial Institutions and Consumer Credit. He said the subprime market should be stabilized, consumers facing foreclosure should receive assistance, and steps should be taken to avoid a recurrence of this phenomenon. Robbins added that responsible lenders extend credit only to borrowers who are willing and able to make mortgage payments, and do not trick borrowers. He acknowledges, however, that “bad loans were made.”

Congress recently entered the fray. In late March, Sen. Charles E. Schumer, chairman of the Joint Economic Committee, said he intends to introduce a bill to crack down on predatory lending and create a federal system to regulate lenders.

Fed Chairman Ben Bernanke has said that lenders failed to calculate the ability of many subprime borrowers to repay their mortgages, particularly for ARMs where payments rise with interest rates. He also said it is worth looking into a federal anti-predatory lending law.

But some analysts think it is an exaggeration to call the current problems in the subprime mortgage industry a crisis, and warn against overreacting.

In a recent article, Austan Goolsbee, professor of economics at the University of Chicago Graduate School of Business, quotes a mortgage analyst who warned in 1981 about the risk of subprime mortgages. He argues that Congress should be mindful of the potential downside of too much tightening of lending regulations, and that subprime lending has led to increased homeownership. He cites a study, conducted by two economists at the Federal Reserve Bank of Boston, that shows a growth in new kinds of home loans from 1970 to 2000. These new types of mortgages have allowed borrowers to make their own decisions about housing, and they generally made good decisions. Goolsbee added that the rise of subprime loans has also opened the door of homeownership to African-Americans and Hispanics.

The Center for Responsible Lending reports that a majority of home loans made to African-Americans were subprime loans; the corresponding figure for Hispanics is 40 percent.

It is for just this reason that a coalition of advocacy groups, including the National Council of La Raza, the largest Latino civil rights group in the nation, is telling lenders to stop foreclosures on subprime mortgage loans. They argue that lenders, real estate agents and investors who bought subprime loans share the blame.

The high subprime delinquency rate and rise in foreclosures has led to a sharp fall in recent weeks in the purchase of bonds backed by subprime mortgages.

This week the chairman of the Federal Reserve Bank of Dallas said the subprime mortgage crisis has been largely contained. He said the financial system and economy is strong enough to weather the storm, and argued that regulatory agencies are striving to avoid radically changing credit standards, which could additional slowdown in the U.S. housing industry and economy.

But there is also evidence that the problems in the subprime mortgage market are spreading to loans called Alt-A mortgages, which, roughly speaking, fall between a prime and subprime market. M&T Bank Corp, a Buffalo, N.Y.,-based regional bank, reports that a recent auction shows investors don’t want to buy its Alt-A loans. Bank officials feel the subprime home loan mess is inching up the mortgage ladder and hurting the rest of the market. They expected more bidders, but ended up selling Alt-A loans for lower prices than expected.

A recent report from the Federal Reserve indicates that 15 percent of U.S. banks began tightening their credit standards in 2006 in subprime and Alt-A markets, making it tougher for borrowers to obtain home loans. One thing’s for sure, politicians, economists and consumer groups will continue to wrangle on the decaying subprime lending industry for a long time to come. Time will tell what the long-term effects will be on the nation’s housing market and the economy.

Found here.

At issue are mortgages made to people who fall in the gray area between “prime” (borrowers considered the best credit risks) and “subprime” (borrowers considered the greatest credit risks). A record $400 billion of these midlevel loans – which are known in the industry as “Alt-A” mortgages – were originated last year, up from $85 billion in 2003, according to Inside Mortgage Finance, a trade publication. Alt-A loans accounted for roughly 16 percent of mortgage originations last year and subprime loans an additional 24 percent.

The catch-all Alt-A category includes many of the innovative products that helped fuel the housing boom, such as mortgages that carry little, if any, documentation of income or assets, and so-called option adjustable-rate mortgages, which give borrowers multiple payment choices but can lead to a rising loan balance. Loans taken by investors buying homes they don’t plan to occupy themselves can also fall into the Alt-A category.

Borrowers who take out Alt-A mortgages are considered less risky than subprime borrowers because of their higher credit scores. But as the housing market cooled and loan volume declined, some lenders lowered their standards for Alt-As. Now a rising number of borrowers who took out these loans are running into trouble.

Data from UBS AG show that the default rate for Alt-A mortgages has doubled in the past 14 months. “The credit deterioration has been almost parallel to what’s been happening in the subprime market,” says UBS mortgage analyst David Liu. The UBS report contrasts with testimony Federal Reserve Board Chairman Ben Bernanke gave to Congress Wednesday. “Our assessment is that there’s not much indication that subprime issues have spread into the broader mortgage market,” Bernanke said.

To be sure, defaults have remained very low in the prime market – and despite the uptick in bad loans, the problems in the Alt-A sector aren’t as severe as those that have roiled the subprime market. Some 2.4 percent of Alt-A loans are at least 60 days past due, according to UBS, which looked at mortgages that were packaged into securities and sold to investors. That is well below the 10.5 percent delinquency rate for subprime mortgages. (During the housing boom, delinquencies were low for all types of loans because borrowers who wound up in trouble could refinance or sell.)

Some borrowers who took out Alt-A loans in recent years are starting to feel the strain. Johnny and Shirley Johnson, retirees in Cleveland, took out an option ARM when they refinanced their $92,700 mortgage in July 2005. The loan carried a 3.5 percent introductory rate that began moving upward a few months later. The couple, who live on a fixed income, are currently making the minimum payment on their loan. But they are afraid they won’t be able to keep up with their loan and other debts once their monthly mortgage payment adjusts upward later this year.

“We don’t want to lose our home,” says Ms. Johnson. The couple is working with Acorn Housing Corp., a nonprofit group that provides housing counseling, in an effort to refinance into a 30-year fixed-rate mortgage. Though the monthly payment would be higher, the new loan would protect them against future increases.

Housing counselors and bankruptcy attorneys say they are seeing an increase in troubled borrowers who previously had good credit. “We have clients with 720-plus credit scores, and they are in awful products,” says Jennifer Harris, executive director of the Home Loan Counseling Center in Sacramento, Calif. Some of these borrowers took out option ARMs with low introductory rates and are likely to fall behind when their monthly payment resets at a higher level, she says.

Thomas Gorman, a bankruptcy attorney in Alexandria, Va., says he is seeing more financially strapped borrowers who “probably bought more house than they could afford and then took on more credit-card debt” to furnish the house and pay for the move. When the housing market cooled, they were “caught in the middle,” unable to sell their home or refinance and make their debt load more manageable.

Lenders are also tightening their standards. At a meeting with investors last week, IndyMac Bancorp Inc., the nation’s largest Alt-A lender, said it had raised the minimum credit score at which borrowers could finance 100 percent of a home’s value and took a number of other steps to tighten lending guidelines.

This week Lehman Brothers Holdings Inc.’s Aurora Loan Services unit raised the minimum credit score and reduced the maximum amount homeowners could borrower without documenting their income and assets.

Impac Mortgage Holdings Inc., which specializes in Alt-A loans, said recently that it had tightened its lending standards 17 times last year. The company cut back on riskier loans and began relying more on analytical tools to verify a borrower’s income and creditworthiness. Other lenders were quick to scoop up many of those loans, but now they are also pulling back, says Impac President Bill Ashmore.

Lou Barnes, a mortgage banker in Boulder, Colo., says a client with a good credit score was turned down this week for a mortgage to buy an investment property with a small down payment and no documentation. That same borrower was approved for a “nearly identical” loan in August and November, he says. Still, Barnes calls the tightening “modest.” Alt-A lenders are “nibbling at the edges,” he says.

The UBS study found that the problems are greatest for Alt-A borrowers who took out interest-only adjustable-rate mortgages, which allow borrowers to pay interest and no principal in the loan’s early years, with 3.71 percent of interest-only ARMs originated in 2006 at least 60 days past due. As in the subprime sector, the riskiest loans are those made to home buyers who put little, if any, money down and don’t document their income or assets.

As delinquencies rise, some investors who bought lower-rated securities backed by these mortgages are likely to face losses, according to Mr. Liu of UBS. While defaults are expected to be lower than in the subprime sector, so are the reserves set aside to cushion bond investors against such losses.

Defaults are much lower for option ARMs. But the problems with these loans could be “backloaded,” says Mr. Liu, because borrowers with these loans are still making the minimum payment.

Glenn Costello, a managing director at Fitch Ratings Inc. in New York, expects the foreclosure rate for Alt-A loans to ultimately be only 10 percent to 20 percent of the rate for subprime borrowers.

Yet investor concerns about Alt-A loans are rising, according to Walter N. Schmidt, a mortgage investment strategist at FTN Financial Capital Markets in Chicago. A report from mortgage analysts at Barclays Capital in New York this week pointed to fraud as one reason for early defaults on Alt-A loans. The mortgage industry is battling a rash of cases in which borrowers, loan officers and appraisers collude in providing false information to induce lenders to advance more money than homes are worth.

Found here.