For anyone who lived through the 2008 housing crisis—the term “subprime mortgage” is associated with images of foreclosure signs and plunging markets.
Although subprime mortgages weren’t the only culprits of the Great Recession, these shaky housing loans did play a major role. Designed for borrowers with low or no credit, lenders handed out subprime mortgages left and right in the years leading up to the crisis.
In fact, back then, the loans were even given their own acronym: NINJA. That stands for No Income, No Job, No Assets. It’s clear, then, why so many people ended up with mortgages they couldn’t afford.
Today, subprime loans still exist (sometimes under the new term “nonprime”), which brings up the question: Should home sellers of today worry if their buyer is getting a subprime mortgage?
What is a subprime mortgage?
A subprime mortgage is referred to as “subprime,” “nonprime,” or “non QM” (non-qualifying mortgage) because the borrower has something in their credit history that disqualifies them for a standard, or “prime” mortgage, as defined by the FDIC. This means that the borrower represents a higher risk for defaulting on their loan, and to make up for that risk, the lender usually charges a higher rate of interest and higher loan fees.
In addition, non-qualifying loans are not insured by the government, which further increases the risk banks take by issuing them, says Movement Mortgage broker Randy Shamburger.
Subprime mortgages are generally given to borrowers with credit scores below 660 or who exhibit one or more of the following risk factors:
- A debt-to-income ratio of at least 50%
- Two or more 30-day delinquencies in the past year
- One 60-day delinquency in the past two years
- A foreclosure within the past two years
- A bankruptcy within the past five years
Lenders do also take into account individual circumstances when reviewing borrowers for subprime or non-QM mortgages, just like they do for conventional mortgages.
“Non-QM borrowers don’t all necessarily have bad credit,” says Shamburger. “Some of those products require good credit to qualify, so the risk that’s involved may have to do with something else in their history.”
What are the different types of subprime mortgages?
There are several types of subprime loans that borrowers may be able to access, depending on their individual circumstances and the lenders they work with.
With an interest-only loan, the borrower pays only the interest on the loan for the initial duration of the loan repayment period (this is also known as negative amortization). While this creates more affordable payments initially, those payments can suddenly grow much larger once the borrower is responsible for paying off the principal as well.
These loans carry an interest rate that is flat, or fixed, for a certain period of time—two years, generally—and then changes over to the adjustable rate, which may be significantly higher.
Fixed-rate subprime loans carry fixed interest rates, meaning borrowers won’t be surprised by a sudden interest rate jump like they might with an adjustable-rate loan. However, these loans often carry higher interest rates to begin with, and can last for a longer duration—40 years, for example, instead of the typical 30.
No down payment loans:
While the subprime loan market in the early 2000s was flush with no money down loans, today it’s much harder to find a 0% down payment subprime loan. Other government-backed loans, like VA and USDA loans, offer no down payment terms, but these are not subprime.
The subprime mortgage crisis, explained: What happened in 2008?
The subprime mortgage crisis, which technically lasted from 2007-2010, according to Federal Reserve History, was the product of the expansion of exceptionally risky subprime and NINJA mortgages, which resulted in increased housing demand and rapidly rising housing prices.
Banks funded these risky loans by bundling them together into packages that they sold to investors.
As housing prices continued to rise, high-risk borrowers were often able to sell their homes for enough to pay off their mortgages and even earn a profit—however, once the housing market peaked, more and more homeowners found themselves saddled with homes that were suddenly worth less than they owed on their mortgages.
Thousands of people defaulted on their loans, and those reverberations were felt throughout the investment markets.
The new subprime loans: nonprime loans or non-qualifying mortgages (non-QM)
Due to greater regulation and the lessons of experience, subprime lending today looks different than it did 10 years ago.
Now known as nonprime loans or non-qualifying mortgages, loans made to borrowers that represent a higher risk of default are essentially the same product—still subprime—but income, job, and asset verification are now the rule rather than the exception.
“Back in the heyday, we had the loans that were basically if you were breathing, if you fogged the mirror, you got the loan,” says top-selling Los Angeles real estate agent Brad Korb.
“Buyers were getting into houses for cheaper than first month’s [rent], last month’s, and security. That market has not come back. I have seen non-qualifying loans, but those are looking for 20% or 25% down.”
Shamburger has seen a major expansion in non-qualifying loans over the past several years as well: “These types of loans were absent for many years after the crash, but those offerings have grown exponentially.”
That larger down payment and the greater verification of assets and income makes the nonprime mortgage today somewhat less risky, even though the borrower’s credit score or history may still be slightly problematic.
Should seller worry if their buyer is getting a nonprime mortgage?
So how does the subprime/nonprime mortgage issue affect home sellers? If an offer comes in from a buyer who’s financing with a subprime loan, should the home seller reconsider?
According to Korb, who’s dealt with a large number of subprime and nonprime mortgages throughout his 40 years in real estate, the answer is no—as long as the seller and his or her agent work together to make sure the subprime loan offer is reliable.
“I really wouldn’t worry if a buyer had poor credit,” Korb says. “If I have someone that I don’t know coming in with a subprime loan, I don’t mind—I just want to make sure we double-check that the person is qualified.”
Korb advises sellers to speak with their agent and make sure the agent is comfortable with the lender who’s making that loan: “If that agent feels uncomfortable at all, they should ask the buyer’s agent for a duplicate loan package and run it by their own mortgage lender that they work with, to verify that the information is real and the person actually is qualified.”
Essentially, it all comes down to a seller and their agent doing a bit of detective work. “You can do as much as you want to do,” Korb says. “I always let the buyer’s agent know we’re not trying to run the buyer’s credit, we just want to be able to see what kind of lending package they’re looking at. You want to protect the seller—you don’t want to go into escrow and find out this thing is going to crash and burn 30 days out.”
Shamburger offers the same advice to real estate agents he works with:
“If someone in my family was selling their house and came to me saying they had a buyer with a non QM, I would want to dig a lot further and ask a lot of questions before I accepted. If the buyer didn’t want to answer, I’d probably move on to another offer, even if it was for a little less money.”
How does a subprime mortgage affect the likelihood of a delayed settlement or terminated contract?
In Korb’s experience, subprime mortgages can result in small closing delays sometimes—perhaps a week or two.
What is more likely to result in a delay, Korb says, is if the buyers are planning on flipping the home—fixing it up and then putting it back on the market. If these buyers are getting a subprime loan that’s also a hard money loan—in which the buyer’s loan is secured by real property—that’s an indication that they may be wanting to flip the home.
What are the benefits of a cash offer versus a buyer with a subprime mortgage or shaky financing?
In almost any home selling situation, cash is king. Cash offers from buyers mean that the entire financing process, from the buyer’s qualification to the appraisal, can be waived. The transaction immediately becomes far more simple. There are very few occasions on which it would be preferable to decline, rather than accept, a cash offer.
One of the reasons a buyer might decline cash is because these offers often come in lower than offers with financing. If getting the absolute highest amount of money possible is important to the seller, they may want to consider higher offers with financing.
If that financing involves a subprime mortgage, it’s absolutely vital that the seller’s agent does their homework to find out as much information as possible about the loan the buyer is getting—up to and including getting a duplicate loan package from the buyer’s agent to run by their mortgage lender.
The last thing any seller wants is for a financing offer to fall through 30 days from closing.
Subprime and nonprime mortgages require a certain amount of caution from a seller and the seller’s agent, but they’re far from what they were back in 2008. If you’re ready to sell your home, you’ll need a top-performing agent to guide you through these types of challenges and more.
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