Bad credit home loan rate

Time was, when you fell behind on your mortgage or missed a credit card payment, you were penalized. Not dragged off to debtors' prison exactly, but you knew better than to ask your corner banker for another loan. That seems a quaint notion today, when borrowers in the market for mortgage loans who would have been shunned as poor risks a few years ago are being pursued relentlessly by lenders.

Lots of borrowers are taking advantage. Some 1.5 million last year, about 15 percent of all mortgage borrowers, failed to meet top-flight credit standards, some by a wide margin, according to the newsletter Inside Mortgage Finance. They got a mortgage nonetheless, paying higher interest rates and often putting home equity on the line to pay off debts or fund other purchases.

Lenders call loans to the credit-blemished the "subprime" market and assign letter grades of B, C, and D (table, Page 58) to borrowers whose faux pas range from a single late payment to a recent bankruptcy. Last ye, some $97 billion worth of B and C mortgage loans were made. That was up 40 percent from 1995 levels, compared with a 23 percent growth rate for mortgages overall.

Profit motive. The subprime boom is one more symptom of America's insatiable appetite for debt--and of a willingness by bankers to lower credit standards in search of customers and profits. No longer is the business limited to a handful of finance companies. New entrants include big, mainstream lenders like Norwest Mortgage and Countrywide Home Loans. In its current fiscal year, Countrywide will rake in 35 percent of its revenues from subprime loans, which account for only 5 percent of its loans overall, estimates UBS Securities in San Francisco.

Subprime loans are lucrative because borrowers who ask for forbearance of a spotty credit record can expect to pay higher rates and comply with more onerous terms than borrowers with pristine records. Rates on subprime loans range from just over 8 percent--about a half-point above conventional loan rates--to as high as 16 percent. Borrowers may pay 5 points or more in fees or prepaid interest (each point equals 1 percent of the loan amount). Borrowers will be asked for bigger down payments as well. Loan amounts typically start at about 65 percent of a home's value and max out at 75 or 85 percent. By contrast, conventional loans, with rates averaging 7.6 percent with 1 point for a 30-year fixed loan, extend borrowers up to 95 percent or more of the home's value.

The subprime market is expensive. But it has put people in homes who otherwise would have had little hope of a mortgage and has allowed others to tap home equity that would have been off-limits to them previously. "I knew there was no way they'd give me a regular loan," says Beverly Linens, 60, a fabric furnishings designer from Portland, Ore. Linens wanted to sell her costly, high-maintenance Victorian home to buy a triplex, where she could rent out parts of the house and live and work in the rest. But a rocky, 10-year stint as a real-estate agent had left her with a history of undependable income and several late or missed payments on her credit report. Nonetheless, Linens was able to qualify for a B-grade, $80,000, adjustable-rate loan at 9.25 percent for the first two years. After selling the Victorian, she paid some debts ("I reached into the past and paid people who never thought they'd see a nickel") and still had enough for a 46 percent down payment on a triplex. Linens moved in last month and is sprucing up the last of her rental units.

Some consumer advocates complain that subprime lenders who used to work with borrowers to bring them up to A level now are too quick to label them subprime and charge them higher rates. Lenders might not be as flexible about accepting explanations for past nonpayments, for instance, says Abdon Ibarra, a housing counselor in the Austin, Texas, office of the nonprofit Consumer Credit Counseling Service. It's important for subprime borrowers to burnish their credit records before they apply for a loan--such as settling an outstanding balance--he says.

Betting the house. Borrowing at subprime rates to buy a home is a bonanza for many borrowers; using a subprime loan to consolidate debt is riskier, say some experts. Trading unsecured credit card debt for debt secured by one's home isn't a bargain when the consequences of default are so much greater, says Jean Ann Fox, director of consumer protection with Consumer Federation of America. "You're risking the roof over your head."

Whatever they use the loans for, subprime borrowers should work toward refinancing to a traditional, lower-rate mortgage, say housing counselors. A caveat: Although many states restrict prepayment penalties to varying degrees, about 50 to 75 percent of subprime loans carry a prepayment penalty, says Judy Berry, president of Directors Acceptance, Norwest's subprime unit. Borrowers could be charged anywhere from six months' interest to 3 percent of the outstanding loan. Norwest and others will let customers pay a slightly higher rate in exchange for removing the penalty--five eighths of a percentage point in Norwest's case.

Once a loan is on the books, subprime lenders often are more vigilant about payment schedules. "In the A-paper market, [if your payment is late] you'll get a notice in the mail 15 to 30 days later," says Inside Mortgage editor John Lewis. "In the subprime market, if your payment is due on the first, you'll get a call on the second."

Such aggressive loan servicing prevents most loans from deteriorating to the point of foreclosure. At least it has so far. Whether more of the loans go bad will be known in a few years, as they mature. Economist Mark Zandi at Regional Financial Associates fears the worst should the economy stumble. In a recession, foreclosures overall could double from current levels and bankruptcies could also double, hitting the 2 million mark, he predicts. Countrywide CEO Angelo Mozilo isn't as gloomy. And he dismisses worrywarts who wonder whether the new mortgage calculus does consumers more harm than good. "Our role is to make good loans to people we feel have the ability to pay," he says. "We're not our brother's keeper." That's a sentiment that borrowers will do well to keep in mind.

The ratings game. Lenders assign letter grades based on loan applicants' credit histories.

Type A borrower. Can borrow up to 95 percent of home's value:

No more than 38 percent of income goes to pay debts

No late mortgage payments in past two years

No more than one 30-day late installment-loan payment in past two years; no more than one 60-day late credit card payment

No bankruptcy filing in past 10 years

Type B borrower. Can borrow up to 85 percent of home's value:

No more than 50 percent of income goes to service debts

No more than three 30-day late mortgage payments in past year; no 60-day lates.

No more than four 30-day late installment-loan payments in past year; no more than two 30-day late credit card payments

Two to four years since bankruptcy discharge

Type C borrower. Can borrow up to 75 percent of home's value:

No more than 55 percent of income goes to service debts

No more than four 30-day or two 60-day late mortgage payments in past year

No more than six 30-day late installment-loan payments; no more than four 60-day late credit card payments in past year

One to two years since bankruptcy discharge

Source: HSH Associates