Subject: WSJ: Subprime Debacle Traps Even Very Credit-Worthy
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Thread-Topic: WSJ: Subprime Debacle Traps Even Very Credit-Worthy
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Date: Mon, 03 Dec 2007 08:18:23 GMT
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Subprime Debacle Traps Even Very Credit-Worthy
As Housing Boomed, Industry Pushed Loans To a Broader Market

By RICK BROOKS and RUTH SIMON

The Wall Street Journal
December 3, 2007; Page A1

One common assumption about the subprime mortgage crisis is that it revolves
around borrowers with sketchy credit who couldn't have bought a home without
paying punitively high interest rates. But it turns out that plenty of
people with seemingly good credit are also caught in the subprime trap.

An analysis for The Wall Street Journal of more than $2.5 trillion in
subprime loans made since 2000 shows that as the number of subprime loans
mushroomed, an increasing proportion of them went to people with credit
scores high enough to often qualify for conventional loans with far better
terms.

In 2005, the peak year of the subprime boom, the study says that borrowers
with such credit scores got more than half -- 55% -- of all subprime
mortgages that were ultimately packaged into securities for sale to
investors, as most subprime loans are. The study by First American
LoanPerformance, a San Francisco research firm, says the proportion rose
even higher by the end of 2006, to 61%. The figure was just 41% in 2000,
according to the study. Even a significant number of borrowers with
top-notch credit signed up for expensive subprime loans, the firm's analysis
found.

The numbers could have dramatic implications for how banks and U.S.
regulators address the meltdown in subprime loans. Major banks, mortgage
companies and investment firms have been rocked by billions of dollars in
losses as shaky subprime loans -- which typically carry much higher, or
rising, rates and other potentially onerous costs -- have increasingly gone
into default. Many analysts expect hundreds of thousands more loans could go
bad over the next several years. The Bush administration and major financial
institutions are working on a plan to freeze interest rates of certain
subprime loans in hopes of avoiding an even bigger meltdown.

The surprisingly high number of subprime loans among more credit-worthy
borrowers shows how far such mortgages have spread into the economy --
including middle-class and wealthy communities where they once were scarce.
They also affirm that thousands of borrowers took out loans -- perhaps
foolishly -- with little or no documentation, or no down payment, or without
the income to qualify for a conventional loan of the size they wanted.

The analysis also raises pointed questions about the practices of major
mortgage lenders. Many borrowers whose credit scores might have qualified
them for more conventional loans say they were pushed into risky subprime
loans. They say lenders or brokers aggressively marketed the loans, offering
easier and faster approvals -- and playing down or hiding the onerous price
paid over the long haul in higher interest rates or stricter repayment
terms.

Sales Pitch

The subprime sales pitch sometimes was fueled with faxes and emails from
lenders to brokers touting easier qualification for borrowers and attractive
payouts for mortgage brokers who brought in business. One of the biggest
weapons: a compensation structure that rewarded brokers for persuading
borrowers to take a loan with an interest rate higher than the borrower
might have qualified for.

There isn't a hard-and-fast rule on what makes a loan subprime. But
generally they are riskier than regular mortgages because lenders are more
willing to bend traditional underwriting standards to accommodate borrowers.
Besides having a lower credit score, borrowers might wind up with a subprime
loan if the mortgage was considered risky for other reasons -- such as
borrowing a higher percentage of income or home value than normal, or
borrowing without documenting income or assets. The resulting interest rates
tend to be substantially higher than for conventional mortgages.

One key factor in determining what kind of loan a borrower gets is his
credit score. Credit scores can run from 300 to 850, and many involved in
the business view a credit score of 620 as a historic rough dividing line
between borrowers who are unlikely to qualify for a conventional, or prime
loan, and those who may be able to. Above that score, borrowers may qualify
for a conventional loan if other considerations are in their favor. Above
720, most borrowers would expect to usually qualify for conventional loans,
unless they are seeking to spend more than they can afford, or don't want to
have to document their income or assets -- or are steered to a subprime
product.

But rising home prices, and the growth of an industry of lenders
specializing in subprime loans, led to an increase in all kinds of reasons
for borrowers with good credit scores to sign up for subprime loans.

"Every single day ... I saw prime borrowers coming through my desk with 660,
680 [and] 720 credit scores," says Thomas Rudden, a former senior account
executive at Mercantile Mortgage Co., a now-defunct subprime lender. Some
were taking out loans as speculators, he believes, while in other cases he
thinks brokers put borrowers into these loans because they thought it was
easier.

Many borrowers figured they would refinance in a few years before the rate
on their loan moved higher -- but falling home prices and tighter credit
standards in the past year have suddenly made that unrealistic in many
cases. "Brokers and agents were telling" borrowers with high credit scores
for the past several years "that it was OK" to get subprime loans, "and
borrowers were wanting to take on more debt," says Mark Carrington,
director, analytical sales and support at First American LoanPerformance.

Confused Borrowers

A study done in 2004 and 2005 by the Federal Trade Commission found that
many borrowers were confused by current mortgage cost disclosures and "did
not understand important costs and terms of their own recently obtained
mortgages. Many had loans that were significantly more costly than they
believed, or contained significant restrictions, such as prepayment
penalties, of which they were unaware."

Lending advocates have long alleged that minority and poor borrowers are
often steered into subprime loans that carry excessively high interest rates
and steep prepayment penalties. But the growing use of subprime loans by
people with higher credit scores suggests that such problems exist among a
much wider swath of borrowers than previously thought and may have little to
do with the ethnicity of borrowers.

Doug Duncan, chief economist of the Mortgage Bankers Association, says the
line between borrowers who can qualify for a conventional loan and those who
can't is blurry. "This perception that 620 is a break between prime and
subprime ... is certainly not the view of the industry," he says.

Lenders make their decisions according to a variety of factors, including
their own policies about risk, he says. Credit scores themselves are based
on a variety of factors, including a consumer's payment history and debt
load, how long the consumer has had credit, how actively the consumer is
looking for new credit and the types of credit the consumer uses.

Lenders say they aren't responsible for borrowers who may have been reckless
in their real-estate investments or their finances, or who have their own
reasons for considering loans with subprime terms. "There are many borrower
requests and situations, and multiple risk factors in addition to credit
grading that go into loan underwriting decisions and often do result in
borrowers with good credit grades accepting subprime loans," Countrywide
Financial Corp. spokesman Rick Simon says.

Credit-worthy borrowers holding subprime loans may turn out to serve as a
sort of shock absorber for the current mortgage crisis. They may be more
likely than traditional subprime borrowers to withstand the double whammy of
declining home prices and adjustable-rate mortgages soon due to reset at
higher interest rates. The data perhaps explain why, so far, nearly 80% of
the borrowers with subprime loans have continued to keep their loan payments
current, according to some analysts. That could indicate the crisis won't
continue to deepen as much as some fear.

But the situation also means that many otherwise credit-worthy borrowers are
stuck with subprime loans whose costs may rise, which could harm them
financially and further tighten pressure on the U.S. economy. Delinquency
rates for subprime loans have been climbing in part because many of these
loans included risky attributes such as no documentation of the borrower's
income or assets. Many were made to first-time home buyers or to speculators
who planned to quickly flip the homes. An analysis by Fitch Ratings of 45
subprime loans that went delinquent early in their lives -- even though the
borrowers had an average credit score of 686 -- concluded last week that
"these loans suffered in many instances from poor lending decisions and
misrepresentations by borrowers, brokers and other parties in the
origination process."

During the housing boom, the lower introductory rate on adjustable-rate
mortgages made them feel closer in cost to regular loans to many subprime
borrowers, but those rates can jump after two or three years. Brokers had
extra incentives to sell those loans, which have terms that often are
confusing to borrowers.

For instance, according to a March 2007 "rate sheet" distributed by New
Century Financial Corp., now in bankruptcy-court protection and no longer
making subprime loans, brokers could earn a "yield spread premium" equal to
2% of the loan amount -- or $8,000 on a $400,000 loan -- if a borrower's
interest rate was an extra 1.25 percentage points higher than the Irvine,
Calif., lender's listed rates.

Borrowers weren't supposed to see the information. Tiny print at the bottom
of the document warned: "For wholesale use only. Not for distribution to the
general public."

On average, U.S. mortgage brokers collected 1.88% of the loan amount for
originating a subprime loan, compared with 1.48% for conforming loans,
according to Wholesale Access, a mortgage research firm. Payouts for
subprime loans have traditionally been higher, in part because these loans
sometimes took more work and the approval rate could be lower. Brokers have
sometimes used the money to help the borrower complete the loan, by reducing
closing costs. But there is "a lot of play in the system," says A.W. Pickel
III, a past president of the National Association of Mortgage Brokers, and
president and chief executive of LeaderOne Financial Corp., a mortgage
lender and broker in Overland Park, Kan. "You have to operate with an
ethical basis."

Critics claim that yield-spread premiums encourage brokers to steer
borrowers into loans that cost far more than they should and create
excessive financial risk. In October, Massachusetts Attorney General Martha
Coakley filed a lawsuit against subprime lender Fremont Investment & Loan
and its parent, Fremont General Corp., alleging that the payments were
unfair and deceptive.

Fremont, which quit making subprime mortgages in March, denies any
wrongdoing. In a court filing last month, the Brea, Calif., bank said that
without access to its loans -- often requiring a lower standard of proof of
income, assets and credit history than traditional lenders -- "many
Massachusetts residents who are homeowners today would never have been able
to purchase homes." Fremont declined to make additional comment.

In most states, mortgage brokers and loan officers aren't under any legal
obligation to put borrowers in the mortgage that best suits them. A
provision outlawing yield-spread premiums was dropped last month from a
mortgage-reform bill now working its way through Congress.

'Duped Into Loans'

Tom Pool, an assistant commissioner for the California Department of Real
Estate, says his office has seen a number of cases involving "totally
ignorant and unsophisticated borrowers who had good credit, but were duped
into loans they had no hope of repaying." But experienced borrowers with
high credit scores are often too casual about the loan process.

A study published last year in the Journal of Consumer Affairs concluded
that some borrowers pay higher rates than they should because they don't
shop around enough. An earlier survey by the Mortgage Bankers Association of
borrowers who had bought a house within the previous 12 months found that
half couldn't recall the terms of their mortgage, says the association's Mr.
Duncan.

Often such loans involve fraud, says Peter Fredman, a California attorney
who has two clients who wound up with loans with high interest rates despite
good credit scores. "Because these people had decent credit scores, the
lenders said they would do a 100% no-documentation loan and that opened the
door for mortgage brokers to do whatever they wanted to do," he says.

Mr. Fredman is representing a couple in their sixties with a monthly income
of less than $2,500 but mortgage payments of roughly $3,400, not including
taxes and insurance. The husband and wife, first-time home buyers with
credit scores of 680 and 667, expected payments of $1,500 a month. They
tried refinancing to lower the cost, to little effect. They haven't made a
mortgage payment since January.


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