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National Mortgage Professional
Aug 14, 2006

The Sub-Prime Forum: It's time to take the leadKen Ormansub-prime loans, delinquencies, non-conforming Welcome to "The sub-prime forum," a column designed to help improve your knowledge of alt-A lending and offer tips to increase your share of this lucrative market. Ken Orman is president and co-founder of Plano, Texas-based Kellner Mortgage Investments. As a mortgage professional, Mr. Orman has more than 14 years of experience working in the mortgage lending industry. Recently, articles regarding the sub-prime mortgage industry have been pessimistic. Article after article addresses shrinking margins, widening spreads, slow housing starts, increasing interest rates and rising delinquencies. The articles about growth and pipeline management seem non-existent. Well, to add to the doom and gloom, it is all true. However, sub-prime lenders recognize that their businesses will continue to flourish if they adapt and make necessary changes. Some changes have been dramatic, mergers and office closings being two of the most apparent. Other changes have been less obvious. For example, correspondent lenders that used to sell loans in bulk are choosing to lock loans as best-effort commitments and sell them flow (one loan at a time). Even though the lenders may not earn as much in premiums and incur fees in this structure, this change helps to better predict earnings and eliminates the hedging risk, provided that delivery times are met. Additionally, secondary marketing managers who securitize non-conforming product by way of collateralized mortgage obligations are offering deals that include loans with higher FICO scores and lower loan-to-value ratios (LTV) to improve servicing predictability and prepay speeds. Even though delinquencies have risen, servicers are taking more time and additional steps to avoid foreclosing on their mortgagors. Workout programs that serve as tools for lenders to calculate and reduce borrowers' mortgage payments for several months are common practice. Borrowers who have lost jobs, had medical or family emergencies or have fallen on hard times witness their mortgage companies taking a partnership approach to debt collection, as opposed to the standard practice of "30, 60, 90, foreclosure." This practice helps to avoid the expense, time and man-hours required for asset recovery, asset management and liquidation. However, not every lender is changing. A common complaint that I hear from mortgage brokers is that sub-prime lenders are dramatically different. Each lender has its own set of underwriting parameters and closing procedures. Technology is proprietary and formatted differently. There appears to be substantial differences between lenders and their programs, rates and yield spread offerings. However, the gap continues to close between conforming, alt-A and sub-prime. Some of the more creative sub-prime lenders have developed broader platforms, and non-prime has become a catchall term for any loan not qualified, for any reason, as conforming. The following is an examination of some of the products that will be widely used in the coming months. First, high-LTV, first-lien cash-out loans will be an exciting market in the immediate future. Sub-prime lenders have created numerous products over the years that have helped borrowers attain financing. In order to help the borrower attain the lowest monthly payment, many sub-prime loans were written on two- to five-year adjustable rate mortgages (ARM). Sub-prime borrowers, who would have been declined in underwriting 10 years ago, have been in their homes for a few years and are experiencing large payment increases as the fixed periods of their ARMs mature. These borrowers are requesting refinances to lower their existing housing payments and also to consolidate debt or pull cash out. Since LTV is typically the most important factor when structuring a sub-prime loan, borrowers whose needs demand 100 percent financing require alternative financing to conforming products. Developing a marketing strategy around refinancing options for sub-prime borrowers has long been a common practice, and it will become more popular in the coming months. There are numerous lead sources available to loan officers who want to assist borrowers in attaining a loan that better fits the borrowers needs. Many Internet-based lead services sell pre-screened leads. Simply open any search engine, type in "mortgage leads" and millions of Web sites will be available for viewing. However, proceed with caution. Many of these services sell outdated leads to several buyers at the same time. Additionally, there are several document-retrieval services that can provide specific information from county records. Borrowers who have obligations to traditional sub-prime lenders can be searched for and sorted by mortgages or deeds of trust. Second, many sub-prime borrowers are applying for and financing second homes and investment properties. According to the National Association of Realtors (NAR), in 2005, 40 percent of all home sales were for investment or second homes, up 16 percent from 2004. NAR's chief economist, David Lereah, cites aging baby boomers as the fuel for this segment of the market. They are in their premium earning years and have a strong desire to diversify their investments. Many sub-prime lenders have begun offering full-doc, 100 percent investment products and 95 percent LTV options for investment purchases and refinances for borrowers who can evidence cash flow with bank statements. These products, which still serve as niche products to many loan officers and brokers, have become more traditional in their offerings. Many sub-prime companies offer the ability to underwrite and price these types of loans through automation. Traditional sub-prime lenders used to neglect this segment of the market. Today, sub-prime lenders rely on investment and second-home borrowers. These borrowers provide a great source of revenue for sub-prime secondary markets, which have thinned margins substantially in the last 12 months. There are several strategies you can employ to generate leads with investors and second-home purchasers in mind. Of course, referral business from real estate agents is a great way to obtain mortgage applications. Having several relationships with productive real estate agents will help substantially in the wake of a slowing refinance market. Moreover, marketing directly to borrowers who own more than one home in a specific county is another good source for leads. These borrowers have a higher tolerance for risk. Obtaining lead lists from services that search county records can be a good source for a direct-mail campaign. Lastly, the most obvious and common loan for sub-prime lenders is the purchase-money, owner-occupied first lien. Even though the real estate market has cooled a touch since last year, sales of new and existing homes remain high. In fact, NAR cites that even though new-home sales were down in March 2006, existing-home sales increased from February 2006. In recent discussions with sub-prime lenders, they expect low- or no-money-down products to make up the majority of their purchase-money volume. A good way to source these loans is to keep in contact with your previous customers. Personalized newsletters, postcards and phone calls keep your name and services in front of your borrowers. The federal do-not-call regulations allow a telemarketer to call a consumer if the consumer has purchased, leased or rented goods or services from the company within 18 months preceding the call. Sub-prime lenders need quality loans to sustain or return to profitability. Without the help of creative and assertive loan officers, lenders will continue closing doors and turning away from wholesale. Sub-prime will be a fantastic market for a slowing conforming refinance market. Set your strategy, aggressively seek out borrowers and keep informed about new products and trends. Wholesalers are only as good as their retail partners. Ken Orman is president of Kellner Mortgage Investments, a nationwide wholesale sub-prime lender based in Plano, Texas. He can be reached at (866) 416-9995, ext. 105 or e-mail ken.orman@kellnermortgage.com.
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