“If you’re self-employed, you’re hosed. If you just started a job, you’re hosed. If you get a bonus, you’re hosed. Just got a severance payment? Can’t count that. I don’t have to do a lot to be a lender. I just have to be normal. Banks have forgotten that (mortgage) loans are collateralized by the home itself.” William D. Dallas
“Banks haven’t forgotten how to be common sense home lenders. Government banking regulators, led by the Consumer Financial Protection Bureau, have forced them to abandon their common sense and good business judgment and follow a rules-based approach (based on form-over-substance compliance). I would summarize it as follows: “We are from the federal government and we know what’s best for consumer borrowers and you don’t, because you are a greedy, for-profit private lender and can’t be trusted”.” Mike Perry, former Chairman and CEO, IndyMac Bank
In Home Loans, Subprime Fades as a Dirty Word
By SHAILA DEWANJUNE 28, 2014
When no bank would give them a mortgage, Martin and Cindy Arroyo bought their home in Los Gatos, Calif., with a subprime loan from Athas Capital. CreditRamin Talaie for The New York Times
CALABASAS, Calif. — Martin and Cindy Arroyo knew they were not ideal candidates for a home loan.
She had gone through a foreclosure after losing her job, and he was finishing his M.B.A. and had not yet found his current position. But they had managed to put together a down payment of more than $550,000, or three-quarters of the asking price for a four-bedroom house in Los Gatos, and thought they would find a bank willing to lend the rest. They didn’t.
So the Arroyos found an alternative: a subprime mortgage.
Despite the notoriety that subprime loans gained as a prime cause of the financial crisis, they are re-emerging, under much more careful control, as one answer to the tight lending standards that have shut out millions of would-be homeowners.
“We call it the sane subprime,” said Brian O’Shaughnessy, chief executive of the Athas Capital Group, which gave the Arroyos their loan.
Subprime loans, which accounted for about 15 percent of all new home loans in 2005 and 2006, are now a tiny sliver of the mortgage market. Only a handful of lenders are offering them, at interest rates from 8 to 13 percent (compared with about 4 percent for conventional loans to highly rated borrowers).
Brian O’Shaughnessy, chief executive of the Athas Capital Group.CreditAnn Johansson for The New York Times
Mr. O’Shaughnessy said his underwriting standards, while more flexible, are tougher in some cases than those of the Federal Housing Administration, which permits down payments as small as 3.5 percent. According to the Athas rate sheet, borrowers with low credit scores, between 550 and 600, must put at least 35 percent down and will get an interest rate ranging from 8.99 to 12.99 percent.
Subprime loans have a thoroughly unsavory reputation — for good reason. But the loans started out with a legitimate purpose: giving people with less-than-stellar credit the ability to buy a home, as long as they paid a premium to compensate for the higher risk.
Traditionally, any loan to someone with a credit score below about 640 (the highest possible score is 850) has been considered subprime. During the housing bubble, when lenders were hungry for loans to package into securities for resale, the subprime label expanded to describe all manner of schemes, including loans with low or no down payments, “liar loans” with no proof of income and loans with a monthly payment so low that the principal actually increased over time.
Those exotic products are now virtually extinct. Governed by an encyclopedia’s worth of new regulations, Athas’s loans generally require down payments of at least 20 percent and documentation of income or assets, as well as an assessment of the borrower’s ability to make the payments. Athas does not offer teaser rates, pick-a-payment options or interest-only payments. But it does offer loans to people whose records are marred by a recent foreclosure or who lack a steady income.
And it is doing just what many economists and consumer groups have urged: making credit more widely available. “Not all subprime lending is abusive. It just happened that all of the abuses happened in the subprime space,” said Nikitra Bailey, an executive vice president of the Center for Responsible Lending. “The regulators now have to be really vigilant to make sure people are getting appropriate loans and they don’t allow the subprime market to get back out of hand.”
Marketed by some lenders as “second-chance mortgages,” only about 0.5 percent of new home loans are subprime today, according to Black Knight Financial Services, a research firm for lenders. That is not enough to bundle into securities for sale to investors, which means the lenders, largely financed by private investors, are for the most part keeping the loans on their books or selling them one by one, an incentive to keep the quality high.
But the lenders say it is only a matter of time before the market for subprime-mortgage-backed securities rebounds.
According to mortgage data from Zillow, the number of lenders responding to inquiries from subprime borrowers started to catch up to the number responding to prime borrowers beginning in the fourth quarter of last year. Large banks are also looking at subprime borrowers because rising mortgage rates have killed off much of their refinancing business. In February, Wells Fargo announced that it would lower the minimum credit score for a home loan to 600, from 640.
More than 12.5 million people who might have qualified for a home loan before the crash have been shut out of the market, Mark Zandi, the chief economist for Moody’s Analytics, estimates. Members of minority groups have especially suffered; blacks and Hispanics are rejected by mortgage lenders far more often than whites.
Despite the new regulations, there is much that is familiar about the new subprime lenders. Athas is based in Calabasas, the Southern California city that was once the home of perhaps the most infamous subprime lender, Countrywide Financial. Athas’s chief competitor, the Citadel Servicing Corporation, is in Orange County, another onetime hotbed of subprime lenders.
Many of the players are the same, too. Mr. O’Shaughnessy met his partner, Alim Kassam, during the bankruptcy of Quality Home Loans, which had bought Mr. O’Shaughnessy’s previous company, Bankers Express Mortgage.
But the vocabulary has changed. Because new federal regulations have created something called a qualified mortgage, or Q.M., which must conform to strict requirements, future lending is likely to be categorized as Q.M. or non-Q.M. rather than prime or subprime. Non-Q.M. lenders will have both more flexibility and more liability, but not all non-Q.M. loans will be subprime.
Among the lenders preparing to make non-Q.M. loans is New Leaf Lending, a division of the Skyline Financial Corporation, based in Calabasas and run by William D. Dallas. In 2007, Mr. Dallas was a subprime lender who told The New York Times that investors had pushed him to make risky loans. “The market is paying me to do a no-income-verification loan more than it is paying me to do the full-documentation loans,” he said. “What would you do?”
Now, he says, the pendulum has swung too far the other way. “If you’re self-employed, you’re hosed,” Mr. Dallas said. “If you just started a job, you’re hosed. If you get a bonus, you’re hosed. Just got a severance payment? Can’t count that. I don’t have to do a lot to be a lender. I just have to be normal.” Banks have forgotten that loans are collateralized by the home itself, he said.
In the case of the Arroyos, for example, the house would have to lose 75 percent of its value for the lender to be at risk. “They just have a formula, and they decide whether or not you qualify without looking at what’s logical,” Ms. Arroyo said of conventional mortgage lenders.
Some employees of conventional banks might agree. Barry Boston, for example, recently left one of those banks for a job at Athas, frustrated by having to turn down so many perfectly fine borrowers and because of the endless paperwork involved in closing a loan. “I couldn’t stand it anymore,” he said. “The wind had been completely sucked out of my sails.”
A version of this article appears in print on June 29, 2014, on page A1 of the New York edition with the headline: In Home Loans, Subprime Fades as a Dirty Word.