Lenders to emphasize mortgage quality

Fremont General corp., the seventh-largest subprime mortgage lender in 2006, announced it would no longer provide the so-called “piggyback” mortgages which usually cover some 20% of a home’s cost and are added as second lien to the original mortgage. They have been widely used as a means of avoiding Private Mortgage Insurance and buying property without making a down payment. The decision was announced to mortgage brokers in an e-mail earlier this week.

If collateral is sold, lenders who provide “piggyback” mortgages receive any of the proceeds only if the property sells for more than the balance on the original mortgage. With the current market’s low demand and falling prices, they can seldom hope to regain their money. In many cases, borrowers who finance 100% of the home’s value with loans, walk away from their homes, often leaving lenders with properties that are worth less than the mortgage amount.

Lenders are tightening their standards and denying credit to borrowers with weak reports. They’re introducing stricter underwriting processes, demanding more proof of income and at least a minimal down payment. Accredited Home Owners said it will no loner provide some of the riskier types of loans and announced that incentive plans for its sales staff will from now on focus on loan quality, rather than volume.

High default levels have led to bankruptcies among lenders, who’ve had to buy back their bad loans from the financial institutions these loans are usually sold to. Accredited Home Owners has repurchased 1% of the loans it sold in 2006, up from 0.83% in 2005 and 0.64% in 2004, and hopes the repurchase activity will decline later in 2007.

Shares of various subprime lenders plunged late last week after some reports of financial loss in 2006 were issued, but many marked a slight increase on Wednesday.

What this all means is, they’re finally realizing exactly how risky those loans are, something experts have been talking about all along. When consumers with less than stellar credit are allowed to borrow 80% and more of their home’s worth without providing any proof of their income, who’s to guarantee that the loan will be repaid? Especially in a market where prices are artificially raised by speculator activity, it’s clear that those “affordable” loans can turn and bite their own originators – which they are doing now.

They kept “educating” consumers on how to borrow more without making down payments or paying PMI by using the so-called “piggyback” loans and “interest-only” mortgages and now they’ve decided the risk is too high and they can’t handle the delinquencies. I’d ask why anyone didn’t warn those people before it was too late. And what were banks thinking when they were lending their money to consumers who clearly were unable to repay these loans and preferred not to worry about it until they were forced to. It seems the money lenders earned on interest and fees on those loans wasn’t enough to cover the losses incurred by depreciation. Well, it seems that the “big players” will survive current challenges, but numerous smaller companies have already left the market.

Let’s hope that healthier lending policies will help stabilize the market, even though it’s hard to find out how exactly that’s going to happen, since housing will become even less affordable for subprime buyers, and if those 10-17% leave the market, we’ll have even lower demand, further decreasing prices and unsold new homes.