Subprime lending is back, but don’t call it that

Unlike the risky subprime mortgages before the financial crisis, these new products have stricter regulations and are under a different name.

Subprime lending is back, but don’t call it that

A tight credit market and shrinking origination volume has opened the flood gates for more wholesale lenders providing brokers with the option to originate subprime mortgages in 2015.


Unlike the risky subprime mortgages of before, the new non-agency loan products of today have stricter underwriting standards—one of the biggest being requiring borrowers to have skin in the game. 


However, the word “subprime” still strikes a nerve with many thanks to shoddy lending practices during the run-up to the financial crisis. In fact, companies such as Seer Capital Management and Angel Oak are using the term “nonprime” for lending that used to be known as subprime.

Before the housing bust, subprime mortgages reigned supreme. These products accounted for nearly $2 trillion in originations at its peak in 2005: It even outpaced agency lending from 2004 through 2006. 


Today, the tide has turned in a big way. Five years into the recovery and non-agency mortgages account for less than 25% of lending volume with the majority of non-agency originations being prime jumbo loans.


Subprime lending was responsible for over $500 billion per year from 2004 through 2006. Now, it is comparatively non-existent at less than $1 billion per year. 


Subprime borrowers have more skin in the game


After being thwarted for years by the nation’s biggest banks and lenders, and stricter rules imposed by federal regulators, the subprime market is poised for a comeback.  


“The definition of subprime has changed quite a bit since the credit crisis. Stricter regulations on ability-to-repay requirements as well as more prudent loan-to-value ratios have led to a significantly decreased number of loan defaults,” Tom Hutchens, senior vice president of sales and marketing at Angel Oak Mortgage Solutions, said. “In fact, since we began issuing non-prime loans, we have not had a single borrower default.”


Today’s non-agency loans require minimum down payments of 20% and proof that borrowers can pay the monthly mortgage. For example, Angel Oak’s non-prime program includes credit scores as low as 500, up to 80% loan-to-value, up to 50% debt-to-income ratio and no pre-pay penalty. 


“We have common sense underwriting,” Hutchens said. “We check to see that all income and assets are fully documented, and we have a track record of stellar performance.”


 Although subprime mortgages fall outside the QM safe harbor, the next generation of subprime lending is still safer than before because of ability-to-repay regulations, he added.


Tight credit market creates opportunity


Hutchens said the average credit score for pre-crisis subprime mortgages was between the mid- and high-500s. Now, it is above 660, which most people would not consider subprime. However, a tight credit market has raised lending standards.


Since the housing bust, the focus on high loan quality, coupled with the heap of red tape on originators, has lead lenders to become twice as shy about mortgage lending. And despite recent efforts made by government officials to ease uncertainties about regulations, many prospective borrowers are still unable to qualify for a mortgage.


Angel Oak is one of a growing number of mortgage companies aggressively increasing its non-traditional mortgage business. The wholesale lender’s nonprime program targets borrowers who have experienced a recent credit event, such as a foreclosure or short sale. 


Whether it is declining origination numbers or competitive pressures, lenders are starting to loosen their purse strings for this underserved market. According to recent data from Ellie Mae, 31% of closed loans in December 2014 had an average FICO score below 700 compared to just 21% in 2012.


However, despite the renewed interest in subprime mortgages, government regulators like the Consumer Financial Protection Bureau have said they intend to keep a close eye on lenders.