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 The news is full of reports on the "Subprime Crisis". While there
are plenty of folks out there who are concerned about it, if a recent
conversation I had with a client is any indication, few actually know
what this is all about.
I was talking with a buyer client that I
am helping prepare for a purchase later this year. She has some
concerns since her qualifications for a loan are not stellar. She felt
confident that this would not be an issue since so many of her friends
that had worse credit issues than her were getting home loans with no
difficulty, some even for 110% of the appraised value of the home being
purchased.
I commented that with the current subprime situation,
it was likely that more conventional loan requirements are likely
reassert themselves. What was her resonse? "What does the interest rate
have to do with it?"
I paused for a moment to try and deduce
where our conversation took a wrong turn. After a few moments, I asked
"I didn't mention anything about an interest rate... what did I say
that made you think about interest rates?" She went on to explain
that, as she understood it, "subprime" meant below the prime lending
rate.
Now perhaps this is not as big a misunderstanding as it
seems to me, but after that chat, I spoke with others who when really
asked what subprime was, could not answer. So lets clear it up right
now. Subprime does not refer to the interest rate or the loan, it
refers to the buyer or borrower being something less than a "Prime"
borrower. What is meant by that is that the borrower perhaps has a
lower credit score, spotty employment documentation, little or no cash,
and perhaps no ability to really document their recent employment
history.
With 13% of all subprime ARM loans currently in some
level of default (ranging from being a few months late to foreclosure
action pending), understading what subprime means is critical.
While
many have applauded the past few years as a great time for folks to get
home loans, it has also been a time of huge abuse. Because of many lax
subprime lending standards, many homeowners find themselves in a
position where they owe mortgages that they cannot afford to pay and
even worse, find that they owe more than the home they purchased is
currently worth.
While some may argue that even if 1/5 of all the
subprime loans default that would not cause a blip in the 40 trillion
debt industry in the US, others argue that the situation can mushroom
into other industries that can only serve to deepen the damage.
Clearly,
lenders have failed a pretty basic intelligence test by not requiring
some of the most basic information to obtain a loan. However, we can
also look to the borrowers themselves for taking on more loan than they
can handle. Finally, I see real estate agents as playing a part in this
as well. As professionals, when we see our clients obtaining a loan
that is beyond their needs, we need to be willing to warn them of the
fact. Of course, if buyers are not telling it like it is to their loan
people in order to get a loan, we may also not have all the facts.
What
can we learn from this situation? A few key things. First, when you buy
a home, you should always have SOME level of equity in the home once
escrow closes. In other words, put some money down. Never lie on your
loan documents to obtain the loan. More importantly, don't lie to
yourself about how much debt you can handle. Always evaluate the loan
from the worst case scenario - which many folks find themselves in now.
When in doubt, ask the professionals around you. Your agent, loan
person, etc. These folks are here to give you the info you need to make
an informed decision, use them.
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