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Subprime Mortgage Lending is Back – Watch Out

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Subprime Mortgage Lending

Subprime mortgage engendered the 2008 economic meltdown that affected the United States and a large part of the world. Lately, it’s in the news again.

As a taxpayer, you need to know the ramifications of its reappearance. The economy is trying to revive. Can subprime mortgage lending send it back into the abyss, from which it is so desperately trying to crawl up?

You’ll find the answer in the ensuing paragraphs. So keep reading.

Noticed any change?

The 2008 crisis boils down to leveraged assets. The number of subprime lending agencies mushroomed to profit off of a market ripe with opportunities. Now think about it. If there were strict laws, similar to the ones regulating invoice financing, preventing those agencies from distributing loans like candies, the crisis probably would have never happened.

Today, subprime mortgage firms operate as if such laws are already set out. They no longer offer the loan with zero money down. And they do a thorough background check. The lender’s credit history, annual income, etc are all checked.

There’s been another change; the interest rate is not too low now. In my opinion, subprime lenders want to send out the message that they want quality customers. Customers who can – at the end of the term – repay the loan. All these are positive changes.

Increase in refinancing?

But even if loans are given to responsible lenders, that doesn’t mean they won’t refinance their homes. Many would. Some are already doing it. Does that mean we are going to see home refinancing ballooning again, finally leading to a crisis?

Maybe. Or maybe not.

Honestly, I don’t have any clue. On one hand, people have become more frugal in money matters. On the other hand, multiple avenues to spend money have opened up. So it’s very hard to tell.

Refinancing to buy Bitcoin

Yes, some people are doing exactly what the subheading reads.

Think I am joking? Read this.

Several experts have warned them not to take such extreme risks, only to buy something that doesn’t have any intrinsic value. But their collective plea is falling on deaf ears. In fact, buying Bitcoin is many people’s financial resolution for 2018.

At the time of writing this article, Bitcoin is trading at a rate of $12000, down 38% from the middle of December 2017. Many who refinanced to invest in the peak, driven by FOMO are now freaking out.

Right now there’s a small number of such people but the number could easily increase. Subprime mortgage lending could act as a fuel to the Bitcoin mania. Thankfully, subprime lenders don’t seem interested to cash in on the FOMO. But that’s not enough when they can do better. How about lending to only those people whose motivation for refinance is something other than crypto investment?

The target market

Subprime mortgage lenders now appeal to a very narrow demographic. In the wake of the 2008 crisis, stricter rules were enforced. Those rules made it difficult for people with low FICO score to get loans. Accredited lending agencies had to decline many requests, only because people making those requests didn’t have requisite FICO scores.

Today, a score below 600 means the request will probably be turned down. Subprime mortgage firms know this and they specifically target people whose requests have met with refusal. Such people are identified as prospective customers by those firms.

The safety checks

The downside of this is the repetition of what happened back in 2008. You might refuse to believe this. Might even argue that no bubble is forming currently which this borrowed money could further inflate.

I agree, Bitcoin does seem like a bubble, but not everyone is keen to invest in it right now. Especially boomers who don’t understand this fully and stay away.

However, it doesn’t take long for a bubble to form and it takes even less time for it to burst. So, subprime mortgage firms must put certain safety measures in place. Measures like introducing a cut off mark. Any loan applicant whose FICO score is below this mark gets automatically rejected.

500 should be the mark. A score below 500 and no loan. A strict rule.

Non-mortgage sectors

This article is on subprime mortgage lending. So it’s unfair for us to discuss anything that’s not related to the mortgage industry. However, what’s happening in the automobile sector lately, requires some attention.

Not digressing from the motif of the article, but subprime lending could be a big issue in the automobile sector in next few years. Deep subprime auto loans have been given to people whose FICO score is less than 300. The interest rate may be well above 20%, but that’s not anything assuring considering the possibility of a domino effect that might start immediately after a crisis begins.

Authorities must pay attention to non-mortgage industries and identify the culprit/s, which, in case of subprime auto lending, are lax guidelines and wall street insiders who allow for a large number of unexamined loans. And this is according to Moody’s Investors Service, which means you cannot take it with a grain of salt.

Conclusion

Subprime mortgage lending is the necessary evil. Credit scoring system being rigid pushes many potential lenders out of the equation. Such people will always opt for subprime mortgage. But authorities must ensure the lenders are operating with recommended and transparent guidelines and the money lended to borrowers is not flowing into a bubble.

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