Misfit Borrowers Attract Lenders as Housing Revives
Raj Date helped write new rules for U.S. mortgage underwriting as deputy director of the Consumer Financial Protection Board. Now he’s building a company that will offer loans to borrowers blocked by the agency’s standards.
Date left the CFPB in January to found Washington-based Fenway Summer LLC, which plans to provide loans, including interest-only financing, to borrowers he considers low risk even though they might carry debt that exceeds the agency’s threshold. He estimates that nonqualified mortgages make up as much as $1.5 trillion of the $10 trillion home-loan market.
“There are plenty of borrowers who are eminently responsible people but fall outside of the bright-line boundaries,” Date said in a telephone interview. “And there’s a meaningful-sized business that can be quite good for borrowers and for lenders and investors to be able to satisfy that need.”
Fenway joins a growing group of companies offering financing to consumers with irregular incomes, damaged credit or past foreclosures as the housing market recovers and rising interest rates drive down demand for refinancing, the industry’s biggest source of business since the 2008 credit crisis. That’s slowly bringing mortgage availability back to Americans shut out of home buying after a real estate crash triggered by loose lending to subprime borrowers.
“At least a few lenders are starting to dig into the nooks and crannies of borrowing,” Keith Gumbinger, vice president HSH.com, a Riverdale, N.J.-based mortgage information website, said in a telephone interview. “These are misfit mortgages because they don’t align well with the new standards in the marketplace.”
Fenway, named after the Boston Red Sox’s ballpark by Date, a Boston-area native, plans to serve people with high credit scores or net worth who still fall outside the qualified mortgage rules, which offer legal protections to companies that issue loans without high fees and other risky features.
Other companies are reviving products to subprime borrowers, usually defined as those with FICO scores below 620 on the scale of 300 to 850. Citadel Servicing Corp., based in Irvine, Calif., raised $200 million in April from a private- equity firm to offer mortgages to those with blemishes on their records such as credit scores below 620 or a recent foreclosure. Athas Capital Group in Agoura Hills, Calif., has begun marketing loans to people with FICO scores as low as 550.
The 2010 Dodd-Frank financial-regulation overhaul mandated that the CFPB create the qualified mortgage rule to curb abusive lending. Under the regulations, which take effect in January, underwriters must consider borrowers’ ability to repay based on current income or assets, employment status, debt obligations, credit history and the maximum cost of a loan in the case of adjustable-rate mortgages.
Lenders who step outside the box won’t be offering the types of “toxic” subprime loans common before the 2008 credit crisis, when borrowers got 100% financing without proof of income or a job, according to Date, who joined the CFPB in February 2011 after working for Capital One Financial Corp. and Deutsche Bank AG.
“The basic rule of the road applies to everybody, which is you have to make a loan to somebody with the ability to repay it,” Date said. “The difference is just that there’s a safe harbor for certain kinds of loans and there’s not for others. If there’s no safe harbor, then you have to be especially confident in your ability to calibrate and price for credit risk. Frankly, that’s what the differentiator is going to be for the firm we’re trying to build.”
Kathy Laurienti, owner of Paisano Sausage Co. in Denver, is buying a $230,000 townhouse in Westminster, Colo., and could use help from a lender such as Fenway. While she has a prime credit score, no personal debt, and $145,000 in her bank account, JPMorgan Chase & Co., will only finance as much as $100,000 of the cost, she said. That’s because she earned $43,000 last year from her company, which lost $12,000, making her ineligible for a higher loan because of debt-to-income restrictions.
She will have to pull the rest from her savings, leaving little for home improvements, she said.
“I paid off $300,000 for my previous mortgage and now they’ll only give me $100,000,” said Laurienti, who’s been living with her mother since selling her last house in May for $525,000. “This is my bank. They know me when I walk in the door. It’s like it doesn’t count anymore.”
Tom Kelly, a spokesman for New York-based JPMorgan, declined to comment on the loan.
While companies entering the market for nonqualified mortgages such as Laurienti’s don’t represent the kind of easy-money lenders that pulled the U.S. into the worst recession since the 1930s, there is a risk the bets will sour if home prices fall and mortgage standards become too loose, said Paul Willen, a senior economist at the Federal Reserve Bank of Boston.
“If house prices continue rising over the next couple of years, these investments look very attractive and there is going to be a lot of demand for them,” Willen said. “The danger would be that people get it into their heads at some point that it isn’t a risky business. When you go back to 2005 and 2006, people had the attitude that it was low risk, high return.”
The subprime industry collapsed in 2007 as home prices fell, foreclosures increased and sources of funding evaporated. Dozens of mortgage companies put themselves up for sale, including Countrywide and Ameriquest, closed down or, in the case of New Century, declared bankruptcy. Weak lending standards also raised questions about the quality of assets held by financial institutions, triggering runs on banks including Bear Stearns Cos. and leading to a global credit freeze.
As the U.S. housing market rebounds—prices rose 12.2% in May from a year earlier, the largest increase since February 2006, according to Irvine-based CoreLogic Inc.—lenders have started catering to a broader set of borrowers.