How Sub-Prime Loans Affect the Innocent Homeowner

By Michael G. MacKenzie, October 15, 2007
Executive Analyst, Community Acceptance Mortgage

For a lot of homeowners, trouble has been brewing for some time. The sub-prime implosion triggered a widespread credit crisis, as nervous lenders tightened standards for even the best, most creditworthy borrowers. That has worsened troubles in the housing industry, contributing to flattening or falling home prices in many markets - as well as widespread layoffs in construction.
Fallout is starting to spread throughout the economy, and may be severe enough to drive the whole country into recession.

Sub-prime mortgages - exacerbate problem credit - generally intended for people with low credit scores (below 620), many lenders have stopped offering a common type of adjustable-rate mortgage, known as the 2/28 ARM.

Since mid-July, five of the six biggest sub-prime mortgage lenders stopped offering 2/28 ARMs. Credit-challenged borrowers now have fewer options. "Many borrowers are not going to be able to refinance," says Deborah Goldstein, the executive vice president of the Center for Responsible Lending.

"We think it's a good thing for consumers," Goldstein says, because too many 2/28 ARMs were underwritten without regard to whether borrowers could afford to repay them. "So we think it's positive that lenders are going to stop offering that product. It does not mean they will stop offering sub-prime loans."

A 2/28 sub-prime ARM has a low initial rate that lasts two years. After that, the rate is adjusted upward or downward. At the first jump, the rate can conceivably climb between 2 and 6 percentage points, causing monthly payments to skyrocket. (In practice, the first rate jump is usually on the smaller end of that scale, but it can keep rising every six or 12 months afterwards.)
When should I refinance? Borrowers who need to refinance their sub-prime mortgages still have options. Some lenders still offer 2/28 and 3/27 ARMs, although the rates might be into the double digits.

And some lenders offer 5/25 ARMs and 30- and 40-year fixed-rate sub-prime mortgages. In addition, there are "expanded approval" loan programs, which allow lenders to offer Federal National Mortgage Association (Fannie Mae)-approved loans to people with blemished credit, but in such cases borrowers will now have to document their incomes, pay principal as well as interest, and, in most cases, pay mortgage insurance.

Is there a light at the end of the tunnel? Homeownership may continue down its windy slope for a while so whatever you do, get expert advice and choose a licensed broker you can trust. He /she will listen carefully to your needs and get you the best rates available while providing you with the facts and helpful advice about your mortgage or refinancing needs.

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