Buying your own home is a major part of the American dream. For most people, this will require borrowing money in the form of a mortgage.
Over 10 years ago, there were many different types of mortgages available. These included “A paper” (for those with perfect credit, provable income and plenty of reserves), “Alt A” (short for alternative to A paper, for those who couldn’t quite meet the requirements of A paper, subprime (for those who couldn’t fit into the Alt A box) and hard money (for those with very poor credit or a property in poor condition).
After the housing and mortgage market crashed, the only loans available were hard money and A paper. This meant that you either had to have all the requirements needed for a bank loan or you had to have a large down payment and be able to afford a higher monthly payment.
After several few years, subprime lending has made its way back into the market. However, the new subprime is nothing like the old subprime that received so much criticism after the market collapsed.
The old subprime consisted mainly of 30-year loans with rates fixed for 2 years and a 2-year prepay penalty. After 2 years, your interest rate was scheduled for a significant increase, sometimes as much as 3% added to the rate.
The new subprime is a completely different animal. You can get rates fixed for 5 years, 7 years or for the full 30-year term of the mortgage. And the best part is that there is no prepay penalty at all for owner occupied homes.
Another major difference is that the rates can be much closer to the rates for an A paper loan.
So what are the main features of a subprime mortgage?
In the old days, before the market collapsed, it was possible to buy a home with no down payment and no proof of income. Clearly, this was a bad idea, as proven by the number of foreclosures that resulted.
While hard money loans typically require anywhere from 30 – 40% down, a subprime loan can be done with as little as 10% down, depending on your credit profile. Most of these loans end up getting done with 20% down or more.
For example, someone with a 680 credit score and no bankruptcy or foreclosure for the last 3 years could buy a home with as little as 10% down. And someone with a 600 credit score and no bankruptcy in the last 18 months or foreclosure in the last 2 years would be able to buy a home with 20% down.
It is now required by law that all borrowers on owner occupied mortgages are able to prove that they have the ability to afford the payments. This means it is a legal requirement to get proof of income.
So how does this affect the self-employed borrower who doesn’t show very much income on his taxes after accounting for business expenses?
Fortunately, we can use alternative methods of proving the ability to pay. We can use bank statements to show what is going into his bank accounts. And we can use asset depletion for those with a large amount of assets but little or no provable income.
As mentioned above, the credit requirements for a subprime mortgage are much more lenient than they are for a typical bank loan.
The amount of time that must pass after a major credit event like bankruptcy or foreclosure before you can get a mortgage is much shorter with a subprime loan.
After a major credit event like bankruptcy or foreclosure, banks require much more time to pass before they will lend to you than what is required for a subprime loan. This allows you to buy a home sooner if you have had something happen.
Credit scores for subprime loans can be as low as 500 but for scores in this range, an explanation of what has caused this would be needed.
Another benefit of subprime mortgages is that they can help in rebuilding your credit. Unlike hard money loans that don’t report to the credit bureaus, subprime lenders do report your payment history which can help to improve your scores so that you can get lower rates on future loans.
What Should I Do Now?
If you have questions or need a loan but can’t get approved by a bank, we are happy to answer your questions. You can reach us at (707) 523-2900 or you can visit our website at http://www.arcequity.com/subprime-loans/.