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
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
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
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
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
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
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 [email protected]