Two years ago, when Lindsay Gambini wanted to buy a $230,000 house in New Jersey, getting a mortgage was an ordeal. Because she had been bankrupt in 1990, the single mother of three could swing the purchase only by finding a lender that cobbled together three high-interest, government-backed loans. But last month when Gambini, director of arts programming at a state college, wanted to refinance, it was a breeze. Despite her credit history, she found several lenders eager to do business. “It was so quick and easy,” she says. In fact, her monthly payments dropped by about $600.
People like Gambini are behind the big boom in the controversial “subprime” mortgage-lending business. Like credit-card companies that issue Visa cards and MasterCards to consumers with poor financial histories, hundreds of mortgage lenders are now vying to give loans to people with tarnished credit. For a price, these companies are giving mortgages to people with spotty employment records, a history of overdue bills, even bankruptcies and foreclosures.
It is a risky business — for borrowers and lenders. For borrowers, there is the chance that they may not be able to keep up with payments on the high-interest loans, and wind up with deeper financial woes, especially if the economy takes a downturn. For lenders, the challenge may be to survive a shakeout in an increasingly competitive industry.
In recent months, Wall Street analysts have suggested that aggressive accounting tactics and overly zealous loan growth have inflated the earnings of subprime lenders, and that some firms could be headed for trouble. Last week, Cityscape Financial Corp., of Elmsford, N.Y., saw its stock plunge after announcing its third-quarter earnings would fall “materially below” analysts’ expectations. The company’s stock has dropped from a high of $32 in January to just $1.56 Thursday.
For the companies that survive, however, profits can be handsome. Profit margins on mortgages to subprime borrowers can be three to four times greater than on mortgages made to people with top-notch credit. “The bottom line is, there’s money to be made,” says William Oetinger, director of broker services for Advanta Mortgage Corp., a unit of Advanta Corp., Spring House, Pa.
The companies package the mortgages they make as securities, which they then sell to investors. A handful of lenders have “securitized” subprime loans for years. But the market for such securities didn’t explode until better standards for calculating their risk were devised a couple of years ago. Indeed, in the first three quarters of this year, securitization of subprime mortgages reached a record high of $46.8 billion during the first three quarters of 1997, up 49 percent from the similar period last year, according to Inside B&C Lending, an industry newsletter.
Many lenders like doing business with subprime borrowers because they aren’t likely to shop around, or haggle over terms, which typically are one to five percentage points higher than the interest rates quoted good credit risks. “They’ll take what they can get,” says Robert O’Toole, senior staff vice president of residential finance for the Mortgage Bankers Association in Washington, D.C.
Of course, when the economy, or the borrower’s personal situation, takes a turn for the worse, such customers stand a real chance of losing their homes. The greater risk of customer delinquency or default is an obvious downside for lenders. “They 1/8borrowers 3/8 do take a lot of prodding to pay their bills, and that adds to servicing costs,” says James Hayden, president of Trevose, Pa.-based Eastern Mortgage Services Inc., the Dauphin Deposit Bank & Trust Co. subsidiary that gave Gambini her loan.
Real deadbeats rarely get mortgages, says Marc Turtletaub, chief executive officer of Money Store Inc., of Union, N.J., one of the largest subprime mortgage originators in the country. He says 95 percent of those who respond to the company’s massive television and direct-mail advertising campaigns never close on a loan. The company’s average approved customer, he says, is part of a two-earner family, has a household income of $60,000 and has lived in one house for seven years. Usually, the borrower has temporarily fallen behind in bill payments because of a layoff, an illness or other proble
Money Store’s interest rates are steep. Currently, they average about four percentage points above the so-called conforming loan rate, typically the lowest a consumer can get. Borrowers also may have to pay a point or two — a fee amounting to 1 percent or 2 percent of the loan principal — which jacks up the annual percentage rate even more. But Money Store promises fast closings. For those beginning to falter at juggling their debts, the ready cash can make a big difference.
That was the case for Vernita Cox, a Los Angeles gift-shop owner, and her husband, Leonard, who works for a data-processing concern. In April, they tried to get a Federal Housing Administration loan at 8 percent from Great Western Bank, a subsidiary of Washington Mutual Inc., Seattle. They wanted to refinance their $145,000 home and consolidate some high-interest debts.
But while they were applying for a loan, they fell behind on their existing mortgage payments, and their application was suspended. The stalemate dragged on for months, as their precarious credit situation worsened. “I was so upset,” says Cox. “We had already paid $350 for an appraisal and credit check. If they weren’t going to give us a loan, why didn’t they just say no?”
In early September, the Coxes gave up on Great Western and applied to Money Store. Within a month, their loan closed — albeit with a 10 percent interest rate. “It went so fast, it was kind of scary,” says Cox. “But I feel fine now. I can pay off all my creditors.”
Barbara Wade, the Great Western mortgage consultant who handled the Cox case, contends that while borrowers on the brink may feel a wave of relief at consolidating their debts, it’s only a temporary fix.
