Chicago Condo Directory

11th Largest U.S. Sub-prime Lender Goes Under….

Ownit Mortgage Solutions Inc., supposedly ranked 11th for issuing U.S. sub-prime mortgages announced its closing this past December 7th. The California-based home lender was purchased for expansion, in 2003, by its CEO William Dallas, Chicago- based CIVC Partners and a group of other investors. 2 short years later it became part-owned by Merrill Lynch & Co., the 2nd largest securities firm in the world.

Ownit, BNC, Countrywide Financial, and several other “sub-prime” lenders have been shutting down, as the housing market slows. The primary reason is that now with the slow in the housing market, home prices are falling, adjustable rate mortgages now face higher payments, so more borrowers are delinquent with payments.

Sub-prime Loans

What is a “sub-prime” loan? Well, a sub-prime loan is a loan with higher rates, that allows less qualified borrowers the ability to borrow the money for a home. The rates are higher to cover the risk of lending money to underqualified borrowers. The higher the credit score, the lower the rate, just as with typical “prime” lenders. However, sub-prime lenders will always have a substantially higher rate than that of “prime” lenders.

Who Gets Sub-Prime Loans?

Well this is a tricky question, because mortgage loans include a lot of variables such as: income, assets, credit score, credit history, and down payment. Typically those with a good score need not worry about sub-prime mortgage loans. Those with fair and moderate credit usually rely on showing proof of income and assets to boost their ability to qualify for a “prime” loan, but sometimes will fall short and have to work with a sub-prime lender. Those individuals with an obvious short-coming in their credit score are the primary target for sub-prime lenders.

So why are sub-prime borrowers in trouble?

A loan that is almost surely exclusive to the sub-prime lending market, is the 2/28 Adjustable Rate Mortgage. Several home owners have found themselves in trouble when the market becomes very slow and housing prices drop, because that unfortunately means, what? Home loan interest rates will rise.

What the 2/28 does for borrowers is it gives them a fixed rate for 2 years and thereafter the rate is increased to that of the current index rate plus a margin.

For example: Imagine taking out a loan for a dollar from a sub-prime lender. The current index rate is 2% which accrues daily in our case, to make the example easier to follow. Your credit is not so good, so you get it from the sub-prime lender at 5%. This 5% is your fixed rate for 2 days (we’re going to substitute days for years to make this all work out).

If our loan term was for 2 days and we have to pay every 12 hours, we would make payments of $0.275 (so twenty-seven and a half cents) every 12 hours to pay back our dollar plus interest to our sub-prime lender.
So in 2 days with the sub-prime lender you would owe them $1.10, whereas with the prime lender it’s only $1.04.

Here’s what’s tricky, after 2 days, your interest rate raises to the current plus a margin. So say you’ve agreed to pay 5% as your fixed, and a 2% margin. Well here is where borrowers get into trouble. Loan terms are never for just a couple of days. But using our example let’s say our term is 30 days.

Well after the 2nd day the rate equals the index’ which in our example will be 6%, because the housing market has slowed and the pricing of houses has plumitted.

So the poor sub-prime borrower is now subjected to an interest rate of 6% + 2% (the margin), which equals a whopping 8%.

I’m sure I don’t even have to finish calculating for home buyers to get the picture. Eventually borrowers can’t maintain payments and default on the loans.

And that’s exactly what is happening to several of the sub-prime lending companies, such as those named above.

So you make the decision, good or bad? Be informed with your choices before selecting a lender and make sure you’re not a prime borrower getting sucked into a sub-prime loan.

Technorati Tags: housing market, adjustable rate mortgages, mortgage loans