Friday, April 04, 2008

Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending

Chapter 9 - Making the Grade

The subprime lending industry graded potential borrowers with one of four grades.  Borrowers were either “A” borrowers, “B” borrowers, “C” borrowers, or “D” borrowers, though there were minor variations from subprime lender to subprime lender in this grading system.  “A-” or “C-” grades were also a possibility, and these grades were dependent upon whether the borrower had “rolling” 30 day late payments on their most recent twelve (12) month mortgage payment history.  No matter what your grade was though, the subprime lender probably had a “deal” for you.

A subprime borrower who received an “A” grade had no thirty (30) day late payments in the past twelve (12) months of their mortgage payment history.  “A” grades could also carry a loftier name such as “Premier Plus,” or other feel good title.  Some subprime lenders also gave “A” grades to borrowers who did have one thirty (30) day late mortgage payment in the past twelve (12) months, though the interest charged on the loan would have reflected the fact that the borrower paid one mortgage payment thirty (30) days late.  A subprime borrower who had received an “A-” grade has had two (2) thirty (30) day late payments in the past twelve (12) months of their mortgage payment history, which could include rolling thirty (30) day late payments mentioned above.

Rolling late payments, as defined by the subprime lending industry, were simply mortgage payments made thirty (30) days late a number of months in a row.  For example, if a borrower had made their mortgage payment thirty (30) days late for up to six (6) consecutive months, it only counted as one (1) thirty (30) day late payment when it came time to be graded.

A subprime borrower who had received a “B” grade had one (1) sixty (60) day late payment on their mortgage in the past twelve (12) months.  A “B” grade was also assigned to subprime borrowers who had made three (3) thirty (30) day late mortgage payments in the past twelve (12) months.  For example, if a subprime borrower made their mortgage payment thirty (30) days late for the month of January, and then paid the mortgage on time for the months of February and March, and then made the April mortgage payment thirty (30) days late, but once again paid the May and June mortgage payments on time, and then paid the July payment thirty (30) days late, would also receive a “B” grade.

A “C” grade was assigned to subprime borrowers who had made at least one (1) of their mortgage payments ninety (90) days late in the past twelve (12) months.  Once again, though, a subprime borrower who had made three (3) sixty (60) day late mortgage payments in the past twelve (12) months would also receive a “C” grade.  In many instances, these “C” graded subprime borrowers would also have had other thirty (30) day late mortgage payments in the past twelve (12) months, but these were simply ignored by the subprime lender as the weight of the ninety (90) day mortgage late payment was the key to the grade assigned.

Subprime borrowers could also receive a “C-” grade.  A “C-” grade was assigned to subprime borrowers who had made two (2) mortgage payments ninety (90) days late in the past twelve (12) months.

Subprime borrowers who had received a “D” grade had made three (3) or more mortgage payments ninety (90) days late in the past twelve (12) months, or, one (1) payment or more one hundred-twenty (120) days late in the past twelve (12) months.  A “D” graded subprime borrower could also currently be in foreclosure and still qualify for a subprime mortgage loan, though in very rare instances did a “D” graded borrower have enough equity in their home to qualify for a subprime mortgage due to loan-to-value restrictions based on the “D” grade.

Note that the subprime loan grading system did not take into account late payments made on automobile loans, credit cards, student loans, or other lines of credit.  Though these type of late payments did and do affect individuals’ credit scores, which we will discuss later, the subprime loan industry’s grading system simply ignored them.

The subprime loan industry’s ignoring of late payments, other than mortgage late payments, provided potential subprime borrowers with a valuable lesson.  That lesson was, if you were in any type of financial straits which may have had to be endured for some time, and were contemplating utilizing the equity in your home to bail you out of these straits, pay your mortgage payment on time, and let your other creditors contend with late payments, because it would allow them to receive an “A” grade.

The soundness of the above mentioned lesson, if you were a candidate for a subprime loan, cannot be overstated.  The higher your subprime lending grade was, the lower the interest rate you would receive if you found yourself needing to utilize a subprime loan.  Additionally, the higher your grade was, the higher the loan-to-value mortgage you could qualify for.  Though the more money you borrowed against your home, that is the higher the loan-to-value, the higher the interest rate you would be charged.

Though paying your mortgage on time was the most important factor when a need arose to apply for, and take out, a subprime mortgage, paying your other creditors late did have a negative effect on your credit score.  And subprime lenders did consider your credit score, also, when you applied for a subprime mortgage.  For example, if a potential borrower, with a perfect mortgage payment history, applied for a subprime mortgage, the borrower would be graded an “A” borrower.  But, if this borrower’s credit score, due to numerous outstanding collections, current credit card charge-offs, judgments, and other late payments was below 500, the borrower would not have been eligible for a subprime mortgage loan, due to the below 500 credit score.  Though the above is an extreme example, it is not unprecedented.

Most subprime lender grading systems allowed for the following loan-to-values, i.e. how much you could borrow against your home based on your credit grade.  An “A” borrower, or “Premier Plus” borrower, with no mortgage late payments in the past twelve (12) months could borrow up to one hundred percent (100%) of the value of their home.  In fact, an “A” borrower of this caliber was very often offered a 125 loan.  A 125 loan allowed the borrower, and the subprime lender, to gamble on steady appreciation of the home, allowing “A” graded individuals to borrow one hundred twenty-five percent (125%) of the value of their home.

An “A-” graded subprime borrower was typically limited to borrowing ninety-five percent (95%) of the value of their home.  A “B” graded subprime borrower was typically limited to borrowing ninety percent (90%) of the value of their home.  A “C” graded subprime borrower was typically limited to borrowing eighty-five percent (85%) of the value of their home, while a “C-” borrower was typicallylimited to borrowing eighty percent (80%) of the value of their home.

A subprime borrower who was graded a “D,” would be limited to borrowing sixty-five percent (65%) of the value of their home, and, as I’ve mentioned previously, rarely did a subprime borrower with a “D” grade have enough equity in their home to allow for a subprime mortgage refinance.

Though subprime borrowers’ credit scores also had an effect on the loan-to-value limitations set by subprime lenders, in most instances the subprime borrowers’ credit score only affected their loan-to-value limitations by five percent (5%).

One last thing.  Though all mortgage lenders, both prime and subprime, charge a late fee when your mortgage payment is not received by the 15th of the month, a mortgage payment does not show as late on your credit report, or affect your credit score, until the payment is actually thirty-one (31) days past due.

Posted by John Venlet on 04/04 at 06:40 AM
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