Access to credit for subprime borrowers is again under attack.
The latest rain arrows is coming from the highest levels of Wall Street, where analysts are questioning the validity of the business models on which subprime securitization is based.
What often goes unexamined are the reasons why the investment community is joining the chorus against subprime lending. Perhaps not too surprisingly, the main reason is money.
The investment community made a fortune investing in securities that were made up of notes and mortgages from subprime originations. But two years ago these securities became devalued because of concerns about the underlying mortgage instruments' quality and stability.
This put many subprime originators out of business and lost money for many members of the investment community who have since become critics of subprime lending.
Only when this devaluation of subprime notes from mortgage originators happened did reports begin popping up about "predatory lending." Only when subprime lending became less profitable for the upper echelon did it become fashionable for the media and legislators to attack lending to individuals with less-than-perfect credit.
The subprime sector is often called the "high-cost" mortgage industry. It is true that homeowners with less-than-perfect credit must pay higher rates and fees than conforming (or good-credit) borrowers. This is because of the higher market risk associated with the loan.
Subprime mortgages are also "high-cost" for the lenders. A nonconforming loan requires more resources and personnel to originate, process, underwrite, close, ship, and fund.
The delinquency rate for LoanGiant's conforming borrowers is approximately 3.5%, with the default or foreclosure rate running approximately 0.5%. On the other hand, the delinquency rate for our subprime or nonconforming loans is approximately 17.5%, with the default or foreclosure rate in excess of 2%.
Our loan-loss reserve for defaulted subprime loans is 65% of the loan amount.
Mainstream banks' refusal to extend credit to less-than-perfect borrowers is responsible for generating not only responsible subprime lenders but disreputable ones as well.
Predatory lending is generally defined as the illegal practices of stripping, or making loan decisions based on the equity in the home rather than a borrower's ability to pay it back; steering, or putting a borrower in a subprime loan when they may qualify for FHA or conforming ones; flipping, or reclosing the borrower year after year despite prepayment penalties; and packing, or adding unnecessary fees and insurance that decrease the received monies.
Another irresponsible practice is often hidden in the dust kicked up by the attack on responsible subprime lenders: repeated cold-calling from "backroom" and "hard money" lenders.
Backroom lenders go after specific borrowers, typically minority urban homeowners. The "targeting" is through the purchase or rental of lists that focus on certain area codes or ZIP codes cross-referenced with credit histories. The consumer does not initiate the contact, but is subjected to constant phone solicitations.
Hard-money lenders typically induce borrowers to sell their home in return for needed cash, and re-sell the home to this borrower on a land contract. However, the lender fully expects the borrower to default. These lenders avoid usury by the purchase/sale of the home to the overextended and pressured borrower.
The outcry of community groups, the media, and now Wall Street against responsible subprime lending is at best confusing an already confused public. At worst it will drive a wedge between Middle America and its greatest asset, homeownership, by inducing blanket legislation against a service vital to a majority of Americans.
Since no one is closer to these borrowers than subprime lenders - which are often the only financial service providers that make time for them - these lenders must recognize the obligation they have to make the world a better place. This will be done best by helping the borrowers themselves understand the importance of working toward low rates, good credit, and consistent savings.
Granted, this is not the quick fix that society is looking for, but it is the most realistic solution. Financial freedom and creditworthiness take discipline and sacrifice.
Mr. Jacob is president and co-founder of LoanGiant.com, a Southfield, Mich., company that markets loans, insurance, and financial planning products for subprime borrowers.
