Borrowers are broadly categorized by the characteristics of their payment history as reflected in their FICO score. FICO risk scores are developed and maintained by the Fair Isaac Corporation utilizing a proprietary predictive model based on an analysis of consumer profiles and credit histories. These models are updated frequently to reflect changes in consumer credit behavior and lending practices. The FICO score is reported by the three major credit reporting agencies, Experian, Equifax and TransUnion.
Borrowers with high credit scores have generally demonstrated a high degree of responsibility in paying their debt obligations as promised. Those with low credit scores either have little or no credit history, or they have a demonstrated track record of failing to pay their financial obligations.
There are 3 main categories of borrowers: Prime, Alt-A, and Subprime. Prime borrowers are those with high credit scores, and subprime borrowers are those with low credit scores. The Alt-A borrowers make up the gray area in between.
Alt-A tends to be closer to prime as these are often borrowers with high credit scores which for one or more reasons do not meet the strict standards of Prime borrowers. In recent years one of the most common non-conformities of Alt-A loans has been the lack of verifiable income. In short, “liar loans” are generally Alt-A.
As the number of deviations from Prime increases, the credit scores decline and the remainder are considered subprime.
The housing bubble witnessed an unprecedented extension of credit to Alt-A and subprime customers.
For more sophisticated borrowers, lenders allowed stated income or “liar loans.” Basically, borrowers would tell lenders how much they wanted to borrow, and lenders would fill out fraudulent paperwork showing the borrowers were making enough money to afford the payments. This is amazingly irresponsible lending, but it was widespread. Once the price crash began, lenders required borrowers to be able to actually afford the payments; of course, this makes many borrowers unable to obtain financing.
Mortgage rates for prime customers were very low because they rarely default. During the rally few defaulted because prices were rising; people just sold if they got in trouble. This allowed banks to originate risky loans at very low interest rates because the loans did not appear risky. Once the market stopped rising, the underlying risk started to show with increasing default rates and default losses.
When prices crashed, defaults rates increased for all borrower classes. Prime borrowers did not default at the high rates of sub-prime borrowers, but they still defaulted at rates higher than in the past; therefore, interest rates increased for prime borrowers as well. The crash in house prices caused all mortgage interest rates to rise. Banks have to make enough money on their good loans to pay for the losses on their bad loans and still make a profit. Higher interest rates make for lower amounts of borrowing, and this in turn leads to lower house prices.
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author’s daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/
[tags]housing, real estate, buying real estate, housing bubble, real estate bubble, house for sale[/tags]
|
|