Bad Credit Mortgage

Bad Credit Mortgage Definition:

Bad credit mortgages also called as Sub Prime mortgages are non conventional types of loan which are given to borrowers who have low credit rating. These borrowers are often turn down by lenders since they have a chance of defaulting on the debt repayment. These borrowers may have a good history of paying bills on occasion but can’t save money for extensive down payment on a house they want to buy.

Bad credit mortgages usually have higher interest rates than the prime lending offered on traditional loans. The additional percentage of interest often hikes upto ten of thousands of dollars when compared with the principal payments over the life of the loan.

Application process:

The application process starts through online research for a mortgage broker who will search for a lender who meets the borrower’s requirement for a bad credit loan. Generally the mortgage broker gets a fee for his work from the mortgage company.

The loan officer from the mortgage lender contacts the borrower to help him fill the application form and other paperwork and collects the required verifications from the borrower and begins the process of loan.

Depending on the type of the loan the verifications include:

  • Pay stubs
  • W-2 forms
  • Bank account statement
  • Investment statements
  • And proof of the value of the property that is being mortgaged

Verification process:

  • The lender checks the credit with one or more national credit agencies.
  • Loan officer verifies if the lender qualifies for the loan
  • Borrowers credit history
  • Amount of mortgage
  • Amount of monthly payment
  • Income of the borrower

Verifying all the above things and also checking the current market interest rate for traditional mortgages, the loan officer will decide the amount of loan to be sanctioned and the interest rate to be charged on the loan.

If the borrower does not qualify for the particular loan applied to, the lender offers the loan with different terms.

History:

Bad credit lending came into existence for a demand in the market for loans to high risk borrowers with low credit. The first lending was initiated in 1993. Statistically in United States 25% of borrowers fall in to this category. In 1998, Federal Trade Commission estimated 10% of new car financing in US was provided by bad credits and out of $859 billion dollars, $125 billion dollars were sub prime.

Securitization and servicing:

Most of the sub bad credit loans given by the mortgage companies were originated for the purpose of selling them in to securitization channel which are special purpose entities called REMICs that issue residential mortgage backed securities, bonds, securities and other investment vehicles for resale to, pension funds and other fixed income investors.

These mortgage originators are owned by some of the major financial institutions like Merrill Lynch, GE which provide a “Warehouse” for their lending.

Examples are “First Franklin” was owned by Merrill Lynch and WMC was owned by GE.

They remain in control of the loans as “Trustee”, “Servicers” and “Controlling class” of the REMIC trusts. They derive significant fees and income from management of Taxes, Insurance and Repair Reserve Funds required by the terms of the mortgage.

If the loans are default then the servicing is passed to “Special Servicers” who obtain “Workout”, “Foreclosures” and Real Estate Owned management fees.

Special servicers are headed by “Directing Class” or “Controlling Class” which include majority lowest class holders of REMIC Trust Securities also referred to as “B- Piece” holders.

The short fall of loan repayment is repaid by Special servicer on GSE or loan seller to REMIC Trust called as “ Loan Depositor”.

Foreclosure fees and REO income form an motivation for Servicers to purchase the servicing rights of the REMIC trusts from Trustees who have the power to restore the servicers. This depends on the terms of the Pooling and Servicing Agreement.

REMIC trusts are “Passive” or “Pass through” entities below the IRS code and are not taxed at the trust stage. REMIC trusts are prohibited from any other business activities. They are taxed completely on any other income they may generate. This is called as Prohibited Income which comes under IRC 860 code.

Advantages:

Individuals who have experienced large financial problems like job loss, previous debt, and unexpected medical issues may be precluded from obtaining a conventional loan. To meet the demand of these individuals so that they can able to buy large purchases like automobiles or real estate bad credit mortgage is a good option.

Disadvantages:

Capital markets operate on the main theme of risk versus reward. The less credit worthy borrowers represents a riskier investment. Therefore lenders charge higher interest rate than they would charge a prime borrower for the same loan.