High-rate home loans boom amid the bust

by Jim Buchta of Star Tribune
Published: September 9, 2002
Section: BUSINESS

Click here to read how loan officer Kris Wilson of Summit Mortgage was able to help a couple with a poor credit score to secure a home loan.

Desperate to use her home's equity to catch up on credit card bills, Lydia Blake refinanced the 7.9 percent mortgage on her north Minneapolis home with one at 13.49 percent. Then she got laid off. Now she can't pay her bills and her home is in foreclosure.

There are many like her these days. As millions of homeowners lower their mortgage payment by refinancing into some of the lowest interest rates in 30 years, another trend is gaining steam: A growing number of people are getting high-interest subprime mortgages.

But the number of subprime borrowers who can't make their mortgage payments on time is steadily rising. That's a concern for those in the mortgage industry who worry that a slack economy finally is beginning to affect the most desperate borrowers.

What's more, the people delinquent on their mortgages aren't just laid-off, low-wage workers waiting for the sheriff to change locks on the doors. Many are middle-income, white-collar workers buckling under the weight of too much credit card debt and an uncertain economy.

Subprime loans carry an interest rate that's higher than those given to people with very good credit and proven employment history. Once the last resort for the riskiest borrowers, subprime loans have hit the mainstream as some of the nation's largest lenders have begun marketing them.

Subprime loan rates range from 1 to 10 percent higher than the best rate available. Fannie Mae, the nation's largest supplier of home loan funds, estimated that 45 percent of all home buyers with bad credit had loans at 10.5 percent or higher.

``People are overextending themselves on credit,'' said Sheila Meagher, spokeswoman with Mortgage Information Corp. in San Francisco. ``And the scratches and dents on their credit records are because they're basically not able to keep up with it.''

Total subprime lending grew from almost $90 billion in 1996 to $173 billion last year, according to Inside Mortgage Finance Publications, and that the loans now comprise 6 to 15 percent of all mortgages, according to Sheila Meagher of Mortgage Information Corp.

As the economy languishes, the prospects for financially strapped borrowers aren't good, Meagher said, adding that subprime borrowers are ``always the first ones impacted by a worsening economy.''

In June, almost 7 percent of subprime borrowers were 90 days or more late on payments or in default; that was up from 4.5 percent two years ago, according to Mortgage Information Corp. of San Francisco.

The delinquency rate for conventional borrowers is about 1 percent and stable.

The industry calls loans at the best rate ``A paper,'' and the rest are ranked by risk, ranging from A-minus down through B, C or even D, with a corresponding rise in interest rates. The worse the credit, the higher the risk for the lender.

Dan Williams, a counselor at Lutheran Social Service in Duluth, said at least 20 percent of his calls are from people with interest rates 4 percent or higher than market rate.

``It's ugly. It's terribly ugly,'' Williams said of the stories he hears from those people.

He recently got a call from a family with a first mortgage of $216,000 at 9.5 percent interest and a second mortgage of $33,000 at 19 percent. Their house is valued at $290,000 and the family earns $87,000, but they're buckling under $55,600 in credit card debt and living paycheck to paycheck.

``It's pretty common,'' Williams said. ``They can keep up on the bills because they subsidize their income with credit cards. That's why their credit card debts are so high.''

More delinquencies

Geoffrey Cooper of the Mortgage Guarantee Insurance Corp. in Milwaukee, one of the largest private mortgage insurance companies in the nation, said delinquency rates on subprime mortgages are now five times the rate of conventional mortgages.

Almost 12 percent of all subprime borrowers insured by MGIC are delinquent, compared with 2.6 percent for those with prime mortgages.

The companies that sell private mortgage insurance recently have raised their rates for subprime borrowers to account for the rising number of subprime loans and increasing delinquency rates. Private mortgage insurance protects the lender in the event of a foreclosure but usually is required only for borrowers with less than 20 percent equity in their homes.

Peter Boyle, vice president of First Residential Mortgage in Burnsville, said that although more borrowers are carrying high debt, the advent of a credit scoring system called FICO also has given a boost to subprime lending.

The FICO system came into existence several years ago as a way to standardize the credit scoring system and make it more objective. The system made it easier for lenders to approve loans quicker, but it also has made it more difficult for people to escape their credit indiscretions because it assigns a numerical value to their credit profile.

And that doesn't allow much room for error if you're a victim of tough economic times, Boyle said.

``I am seeing more late payments, bankruptcies and people not able to handle debt, but that's par for the course in a recession,'' he said.

A FICO score is a number between 300 and 900 derived largely from the borrower's income, credit history, debts and ratio of income to debt. Typically, 620 is the lowest score that would qualify a borrower for a market-rate loan.

Interest adds up

Kris Wilson of Summit Mortgage in Bloomington recently did a loan for a couple with a credit score of just under 620 because of tax problems and late payments.

Their loan amount was $219,600, and they locked in at 7.875 percent in late June. The seller paid a half-point. If they had qualified, the prevailing rate for borrowers with good credit that day was 6.5 percent.

Over the life of that 30-year loan, it will cost them $353,610 vs. $280,087 in interest for the 6.5 percent loan. Their monthly payment would have been $1,388 rather than $1,592 in principal and interest.

They're lucky, considering the recent increases in mortgage insurance premiums. If their loan had closed one month later, their mortgage insurance premium would have gone from $95.16 to $164.70 a month.

If their credit score had been worse - less than 574 - their premium would have gone up to $360 a month.

Despite the risk, many mortgage companies are getting into the subprime business because of the huge upside potential that comes with higher rates and fees charged to borrowers with less-than-perfect credit.

Jordan Ash, executive director of the Minnesota office of ACORN, blames the proliferation of subprime mortgages on lenders looking for the extra profits from higher interest rates and fees charged to subprime borrowers.

ACORN - the Association of Community Organizations for Reform Now - has been active in trying to curb predatory lending practices that have landed people such as Lydia Blake of north Minneapolis in situations they can't get out of on their own. Many subprime lenders have been accused of gouging their customers and using unscrupulous sales practices.

``Yes, people have more credit card debts and expenses, but subprime lenders have become more aggressive,'' he said. ``Much of the need has been manufactured by the lenders themselves''.

- Staff writer Neal Gendler contributed to this report.