WASHINGTON -- In today's mortgage market, the term "subprime" has become something of a four-letter word, with the popular misconception being that anyone with less than a prime loan is some kind of derelict, a slacker who probably should never have gotten a mortgage, no matter how high the rate.
In mortgage parlance, subprime is the term used to describe that group of borrowers who don't measure up to the high and rather rigid standards of conventional lenders. Perhaps their credit histories are pocked with late pays. Or maybe they haven't been on the job long enough to qualify for a prime loan at the lowest rate and best terms.
But just who are these subprime borrowers we keep hearing about? And why are they in so much trouble? Are they really all just deadbeats?
Certainly, some are scofflaws who never intended to meet their mortgage obligations. But for the most part, they are people just like you and me who wanted to get in on the housing gravy train while it was still chugging uphill.
Yes, a certain number shouldn't have been approved for a mortgage at any price. Their financial situations were so faulty that there was simply no way they could be successful owners.
But a closer look reveals that the group of borrowers who have been forever labeled second-class citizens cuts a wide swath across society. They are our friends and neighbors, perhaps even our own family members.
"It's difficult to define a subprime borrower," says Jay Brinkmann, vice president of research and economics at the Mortgage Bankers Association in Washington, D.C. "But this much is true: If you make 11 payments during a year but at some point have difficulty coming up with the 12th one, that's what makes you subprime. And if you are living on the edge and miss just one payment, it is very difficult to get caught up."
According to the MBA, moreover, most subprime borrowers are making their house payments on time, just like everybody else. The latest delinquency rate among the group of borrowers who are categorized as subprime is 22 percent, the trade group reports. That means 78 percent are current.
Yes, the default rate for subprime borrowers is much higher than that of prime borrowers.
It's also somewhat higher than it was a few months ago, and it will probably go higher in the future. But for now, nearly four out of five subprime borrowers are making their payments each and every month, a fact that gets overlooked in the horrid details of mortgages gone bad.
That said, let's take a closer look at the bucket of borrowers classified as subprime. To some extent, there is overlap with groups described below. But to paraphrase the great philosopher Pogo, we have met the subprimes and they are us:
-- Former primes: Perfectly fine, stand-up people often have life events that knock a them down financially. Perhaps they lost their jobs, are going through a divorce or are suffering from a catastrophic illness.
Greg Lumsden, president of Full Spectrum Lending in Pasadena, Calif., the subprime lending division of Countrywide Home Loans, calls them "fallen angels."
"It's not their fault," Lumsden says. "When we got into the subprime business in the late 1990s, the majority of borrowers came from prime land. They were prime at one time but somehow got into trouble."
According to Experian, the average credit score of someone with just one missed payment in the last year drops a typical credit score from 759 to 598, a number that pushes borrowers into a territory where loan rates are two or more percentage points higher.
-- Future primes: People who have messed up in the past are taking higher-rate loans with the promise that if they make their payments on time for one or two years, their rate will be lowered automatically. These loans are known variously as "credit repair" or "credit comeback" mortgages, and they work, says Lumsden. Some 55 percent of subprime borrowers who are refinancing today are moving from subprime to prime status.
-- Rookies: Many first-time buyers simply lack a large enough down payment or do not have the extensive credit and/or employment histories necessary to qualify for the best rate and terms.
But they go ahead anyway, thinking perhaps that they'll refinance in a few years. About a third of all subprime loans issued to people buying homes were made to first-time borrowers, according to MBA's figures.
-- Second homers: A handful of all subprime loans went to people buying vacation (2 percent) or investment (5 percent) properties, according to the MBA's figures.
Either way, it's safe to say that while their credit records may have been good enough to purchase a first home with a prime mortgage, they didn't have enough credit to obtain a prime loan on another home or their credit records were no longer good enough to do so.
-- Fraudsters: It doesn't matter to con artists what rate they are charged; they don't intend to make any payments. Through numerous scams, their goal is to collect huge sums of money from lenders and then head for the hills, never to be heard from again. So they qualify for whatever loan they can.
-- True believers: Somewhat akin to rookies, these are buyers who want to ride the wave of home price appreciation at any cost.
They believe the trip will last forever, but as history has shown time and again, the wave eventually curls and crashes.
And now there are a bunch of subprime borrowers who owe more than their houses are currently worth. They simply got in too late.
-- Ne'er-do-wells: These are the people who never should have been approved, period. They are habitual late payers, or worse -- no payers. Their finances are such a mess that they can never be straightened out. Yet they, too, want to cash in on the American Dream. And they often find someone to walk them blindly into what quickly becomes a nightmare.
-- Victims: Here's where the true horror stories come from. The media is full of reports about unknowing, uneducated borrowers who have lost their homes thanks to unscrupulous mortgage professionals.
Industry representatives tend to downplay this as only "anecdotal" evidence that does not point to a larger problem. But the truth remains that unprincipled brokers or lenders have hoodwinked too many people into taking dangerous loans with inordinately high rates, expensive prepayment penalties, impossible balloon payments and various other killer features.
-- Should haves: Then there's whole other group of borrowers who could have qualified for a prime rate had their applications been underwritten more carefully -- or even correctly.
Perhaps they were dealing with loan brokers who pushed them into subprime territory to collect a larger commission. Maybe their lenders didn't want to go the extra mile to qualify them for a lower rate. Or perhaps they just fell through the cracks.
Whatever the case, they should have received a prime loan but didn't.
-- Others: This catchall category includes borrowers with adequate credit qualifications who have complicated pay structures.
According to Jake Domer, senior vice president for subprime lending at Washington Mutual in Seattle, Wash., this group includes folks paid on commission or people who use alternative documentation such as bank statements to qualify, probably because they don't want anyone to know their true incomes.
This bucket also catches people who are living together -- a brother and sister, for example, or two extended families. They might have adequate credit on their own but do not qualify as individuals for prime pricing, Domer says.
Lew Sichelman has been covering real estate for more than 30 years. He is a regular contributor to numerous shelter magazines and housing and housing finance industry publications.
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