Historically, lenders made subprime loans to borrowers with damaged credit or inadequate credit histories. These mortgages, which carry interest rates substantially higher than the prime rate, include compensation paid to lenders for the increase risk.
The combination of historic low interest rates, falling home prices and new home construction have many housing advocates calling for a new type of “subprime loan,” which will cater to individuals with lower income or faulty credit.
Faith Bautista, of the National Asian American Coalition, said it would help many former homeowners who were caught in the mortgage meltdown, and suffer job loss or damage credit, chance to rebuild their finances. Many of these people have found new jobs and saved the necessary down payment.
New Mortgage Proposal
The “Dignity Mortgage” will start with a higher interest rate. However, after five years of making payment on time, borrowers will receive a rate cut. Homeowners would start with an interest rate 1.25% above the going rate. For example, if more creditworthy borrowers pay an interest rate of 3.75%, individuals with Dignity Mortgages would pay an interest rate of 5%.
After the fifth year of making mortgage payments on time, the lender would use the extra money paid in interest to reduce the outstanding mortgage balance. In addition, the interest rate paid by these borrowers would be reduced. The new rate would reflect the same interest rate paid by borrowers with the best credit, and who made 20% down payments on their homes, at the time the Dignity Mortgage was made.
Borrowers like Pattie and Ollie Sibug of San Diego, CA, who lost their home improvement business and home are now renting a townhouse. They recently turned turn down an offer from the owner to purchase the home because of their blemished credit scores. “There's got to be some kind of program to help you reestablish yourself," said Pattie Sibug.
Housing Advocates Pushing for Solutions
The new mortgage proposes has been strongly pushed to bankers and federal regulators. It part of an ongoing strategy by housing advocates to demanding that mortgage lenders pay billions of dollars to compensate for the damages caused by the industry’s faulty and questionable lending practices.
The new rules already require lenders to have to increase the amount for capital reserves to cover their housing portfolio losses. After the financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act changed lending practices. Just last month, the Consumer Financial Protection Bureau released new regulations that outline new guidelines for mortgage products.
In response to additional regulatory oversight, mortgage lenders have tighten the credit underwriting criteria beyond requirements set by Fannie Mae and Freddie Mac. These government agencies insures most of the mortgages made since late 2008—providing much needed support of the housing and mortgage industries after private lenders bailed.
Critics Feedback
The former chief credit officer of Fannie Mae Edward J. Pinto, believe that less stringent credit standards by the Federal Housing Agency (FHA) was a major cause of the foreclosure crisis that occurred in many low-income neighborhoods. Pinto calls the Dignity Mortgage “a stupid and crazy idea — a poison pill." Pinto questions whether anything has been learned from undermining the housing finance market.
The CEO of Bank of America Brian T. Moynihan seems to agree. "By being overly aggressive, the entire housing system caused a great deal of damage to the very people we were trying to help attain homeownership," according to Moynihan.
The bank recent announced that it would seek to get back into the mortgage origination segment. This intention surprised some analysts considering Bank of America has more than $40 billion in losses from the loan portfolio it inherited after buying Countrywide Financial—the preeminent subprime lender during the last real estate boom
Moynihan believes that too high credit standards locked individuals out of buying a home and belies a balance must be found between credit underwriting standards, down payment requirements, and the ability to own a home.