Sub-prime lenders are bracing for a storm of loan defaults that are going to cost them millions of dollars. They are shutting down their sub-prime loan windows. It could take years before they resume making these loans.
What is a sub-prime lender? It is a lender that has advanced loans up to 100% of appraised fair market value to borrowers who had FICO credit scores ranging from about 550 to 600. A low credit score denotes that the borrower has had problems with credit; or might have. When someone lends them money, higher interest rates and loan closing charges are assessed to compensate it for additional risk.
Now, many of these lenders are discovering that they probably weren't charging enough to offset risks that weren't easily seen in the rising market, but which are glaringly apparent now. When multiple loan defaults occur, it cuts into available cash at the same time as the company's collection and foreclosure costs are rising. Sub-prime lenders typically raise money through reselling its loans with recourse, or issuing stock selling shares in the stock market. Now shares of the leading sub-prime lenders are dropping like a rock.
This poses both problems and opportunities. Fixers, flippers, and dealers who relied upon sub-prime lenders to finance buyers who would cash them out are going to have hard times. Other victims are those who want to buy a house, but who are not going to be able to get a loan. Not to be overlooked are those who advanced money to any of the above on what were supposed to have been short term loans that now can't be refinanced. This is going to freeze a lot of money and also remove a lot of money from the market.
Who is going to benefit from the shortage of sub-prime loan money?
Well heeled investors and entrepreneurs willing to run higher risks to get higher yields on their invested funds. With the big competitors closed down, the small investor is going to be able to invest even small amounts of money at high rates to all the above named parties who are being squeezed by the shortage of mortgage money. They'll need to be very cautious about getting true valuation and only lending a small percentage of that. For example:
If a house that is being sold is deemed by the lender to be worth $150,000 and the buyer has a 580 credit score, then the lender might lend about $90,000 on a first mortgage at 18% and expect the seller, or a third party, to provide the financing for the remaining $60,000, perhaps with zero payments or with low interest until enough additional equity accrues, or other lenders enter the market and cash him out. In the meantime, landlords are going to
have a field day in an ever tightening rental market where rents together with bottom line profits can be raised with each new tenant.
Have you figured out where you are in this scenario?
What are you doing about it?
