Subprime lenders yank most popular loan type
Cause and effect of easy borrowing
Underwriting for subprime ARMs was so lax in 2005 and 2006 that
hundreds of thousands of borrowers fell behind during the initial
two-year period, before their loans reset and the payments jumped.
At the end of March, almost 16 percent of subprime
ARMs were at least 30 days past due, according to the Mortgage Bankers
Association. That's high, and the default rate is bound to get even
worse as subprime ARMs reset over the next couple of years.
Wall Street and Capitol Hill were surprised by the
high default rates, and pressure from both places led to this month's
sudden scarcity of the 2/28 subprime ARM.
On Wall Street, investors' demand for bonds backed
by 2/28 ARMs abruptly dried up because the loans were perceived
as too risky. Unable to sell the loans on the secondary market,
lenders stopped offering them to consumers.
That was the explanation offered by Countrywide, the
largest mortgage lender (both prime and subprime): "Due to
the current market environment for subprime collateral, Countrywide
is no longer able to offer subprime 2/28s," the company said
in a terse statement. "The decision reflects substantial tightening
of secondary market demand for this product."
HSBC Finance was the nation's second-biggest subprime
lender at the beginning of 2007. An HSBC spokeswoman says the company
still offers 2/28s, and "we are always evaluating if and how
we will offer this product going forward."
The next four largest subprime lenders -- Option One,
First Franklin, Wells Fargo and Washington Mutual -- withdrew 2/28
ARMs in the last few days. First Franklin and Washington Mutual
eliminated 3/27 ARMs, too.
Some options remain
The only lender that was willing to talk at length about the decision was Washington Mutual. David Schneider, president of WaMu's home loans division, says the lender will continue to offer 5/25 subprime loans, in which the introductory rate lasts five years. When WaMu pulled the plug on 2/28s and 3/27s, the introductory rate on 5/25 subprime loans was one-eighth of a percentage point higher than on the 2/28.
"The difference in rate is fairly small," Schneider says. "We think it also gives borrowers more time with stability of payments versus having shorter-term loans with the possibility of rate increases."
WaMu announced other changes in the way it underwrites subprime mortgages. All subprime borrowers will have to document their income instead of merely stating it without providing proof, and taxes and insurance must be included in their monthly payments. Every borrower will be contacted by someone from Washington Mutual, even if the loan was originated indirectly through a broker. WaMu describes these commonsense standards as "industry-leading," with justification, which goes to show how reckless subprime underwriting became in the last two years.
The withdrawal of 2/28 ARMs, plus tighter underwriting standards such as the ones that WaMu implemented, follow months of pressure by federal regulators. At the end of June, the agencies issued guidelines telling lenders to qualify borrowers based on their ability to repay subprime ARMs after they have reset to higher rates.
The regulators told lenders that they should require subprime borrowers to document their income because doing so "is critical to conducting a credible analysis of borrowers' repayment capacity, particularly in connection with loans to subprime borrowers."
Yes, federal regulators actually had to tell lenders to verify the incomes of credit-challenged customers who want to borrow hundreds of thousands of dollars.