Once blamed for the collapse of the U.S. housing market and the Great Recession that followed, subprime mortgages, or high-risk home loans made to borrowers with poor credit, are making a comeback with a new name: nonprime mortgages.
This time around, however, these loans come with new standards to comply with tighter regulations and ease the concerns of investors, many of whom swore never to look at these risky mortgages again.
How Do Nonprime Loans Work?
Lenders manually underwrite each nonprime loan and carefully assess the borrower’s risks to determine his or her ability to repay (ATR). This allows prospective homebuyers with low FICO scores, who normally can’t qualify for agency-backed mortgages (which usually require scores in the 700s), to take out loans of up to $1.5 million on townhomes, single-family homes, and condominiums. Homeowners can also tap into the equity of their homes for cash-out refinances of up to $500,000.
Borrowers who have experienced major credit events, such as bankruptcy or a foreclosure, or have a history of frequent late payments, things that usually have disastrous effects on FICO scores, can also qualify for nonprime mortgage.
Although underwriting standards of nonprime mortgages are loose than those required by loans purchasable by government agencies like Fannie Mae, they still go back to the overarching principle of ATR, with lenders looking at a host of factors aside from credit to determine if a borrower has the means to pay back the loan.
What’s the Catch?
Because each nonprime mortgage is underwritten manually, this means that not all loans will be the same for all borrowers.
For example, a borrower who has just filed for bankruptcy is deemed a higher risk, which often means that person will have to make a larger down payment and shoulder higher mortgage interest rates compared to a borrower who’s only issue is habitually making late payments.
In other words, the underwriting standards behind nonprime loans involve identifying risks and offsetting these risks elsewhere, ensuring that people with challenging credit still have loan options to help them become homeowners.
Who Benefits from Nonprime Loans?
As the economy returns to normal and rent prices continue to rise, the number of Americans trying to become homeowners has also increased, many of them stilling bear the scars of the Great Recession in the form of low credit, high debt, and underemployment among others.
The growing demand for loan products from high-risk borrowers is especially pronounced among millennials. Although they are currently the largest home buying cohort, millennials are also saddled with much more student debt than previous generations.
On the other hand, members of older generations, who know firsthand what it was like to have their homes foreclosed during the housing crisis, are still struggling with low FICO scores, freezing them out of the mortgage market.
If you would like to learn more about how to qualify for nonprime loans, get in touch with mortgage advisor Chris Lamm to discuss requirements, as well as any pros and cons you need to know. Call our offices at 530-282-1166 to schedule a consultation.