Subprime lending, often associated with the run-up to the 2008 financial crisis, seems to be validating the theory of reincarnation. Whether or not it is back in full throttle is still widely debatable. What’s however clear is that, just like it was before the recession, some home lenders are lowering their lending criteria in order to counter the rising housing prices that have cooled demand and in effect sales.
Just as a recap, subprime borrowers often have a credit score of below 620 and are considered to carry high risk of default. In the run-up to the 2008 financial crisis, home lenders lowered their criteria to hook and reel in subprime borrowers, with catchwords such as “no money down” and “no extensive documentation” being formidable tools in home lenders’ arsenals.
While everyone is all too familiar with the painful recession that succeeded the subprime lending boom, the practice is regaining acceptance among home lenders, albeit in a less pronounced fashion relative to the years before the crisis. Moreover, the home lenders who are tiptoeing back to subprime lending, are saying that despite the loosened requirements, the kind of subprime loans they are currently giving are not the same as the ones which drove the economy down the drain in 2008. Whether or not this assertion is true remains largely untested. But in the interest of stating all the facts, lenders have said that subprime borrowers should expect high levels of scrutiny aimed at establishing why their credit scores are so low.
Earlier in the year, home-lending bigwig Wells Fargo (NYSE: WFC) dropped its credit score for home-purchase loans backed by the Federal Housing Administration from 640 to 600. Ditech Mortgage Corp, which according to Housing Wire was “once a poster-child for pre-crash subprime lending,” is back after prolonged absence from the market. The lender is looking to carve out a sizeable niche in direct consumer lending, retail lending and correspondent lending with its 600 plus institutional partners.
A Proclaimed Return Could be in the Works
For now, most lenders have quietly reintroduced subprime lending, and their eyes are still warily darting around to survey for any unwanted attention from regulators or the media. However, depending on how the economy progresses, subprime lending could make a proclaimed return in the midterm.
The Federal Reserve, according to April 30th minutes, has not given a timetable of when it will increase interest rates, which have been at near zero rates ever since the financial crisis. This has certainly cooled speculation that rates will rise in the near future and that credit will become more expensive. This however does not mean that the argument that rates may rise soon is entirely misinformed. The risk of inflationary wage pressure is still high in view of the declining unemployment rate, which at the current 6.3 percent is the lowest in five years. Further declines in unemployment could see the actual rate of unemployment converging with the natural rate of unemployment in the near future, which is the rate where wage inflation starts kicking in. The consensus estimate is that the U.S. natural rate of unemployment is somewhere between 5 percent and 6 percent.
If inflation does rise, the Fed may be compelled to increase interest rates sooner rather than later to reduce the amount of money in supply. Inadvertently, this will make housing even more unaffordable, potentially providing sufficient impetus to thrust subprime lending back to the foreground.