Tighter Underwriting Stymies Refinancing of Subprime Loans

Tighter underwriting standards will help protect new borrowers from being pushed underwater by exotic forms of adjustable-rate mortgages, panelists agreed here at the Mortgage Bankers Association's Nonprime Mortgage and Networking Conference last week.

But several speakers warned that not enough attention is being paid to the plight of millions of borrowers who already have those loosely underwritten products and face the prospect of not being able to refinance when their loans reset this year and next.

Particularly vulnerable, they said, are subprime borrowers who have not been able to improve their credit standing in the short time they have had their interest-only mortgages, pay-option loans or short-term two- and three-year adjustable mortgages.

"Yes, credit quality is much better today," 30-year industry veteran Michael McQuiggan told the conference. "But how are we going to take care of all those customers who can't qualify for refinancing because their homes aren't appreciating as they expected?"

Mr. McQuiggan, chief executive officer of Lenders Direct Capital Corp., an Orange County, Calif., marketer of nonprime, alt-A and second-mortgage loan products, which shuttered its wholesale division earlier his year, said the entire industry has an obligation to address the problem and the sooner the better.

"This is urgent. We must do it now or it's going to snowball," he warned. "We've got to get everybody involved in this - Wall Street, the rating agencies, Realtors, homebuilders. If we don't solve the problem immediately, it will take on a life of its own and the government will come in and solve it for us."

Steve Nadon, president of Option One Mortgage Corp., agreed, saying that the potential debacle is "not owned by just one segment" of the housing sector. "It involves everyone," Mr. Nadon told the conference. "We need to all get together and find a solution."

In his remarks opening the three-day conference here, MBA chairman John Robbins did not maintain that the pending nightmare is an industry-wide problem. But he did warn that the housing finance sector and those that oversee it "cannot abandon the millions of homeowners who already have these products."

While regulators and legislators are considering actions that will make it more difficult for subprime borrowers to obtain what some call "toxic" loans, the San Diego mortgage banker lashed out at Freddie Mac, which said recently that it would buy only 2/28 and 3/27 product that is underwritten at the fully indexed rate.

If the ability to qualify for such loans is taken away from borrowers with credit issues, the MBA chairman warned, millions of borrowers - most of which are minorities - will be "trapped."

"This draconian decision only serves to exacerbate the foreclosure problem," he said.

In his remarks to the conference, Mr. Nadon said he had every confidence that the nonprime sector would work its way out of its current tailspin, a nosedive he said the business brought on itself.

"I've never seen anything like we're experiencing now," the Option One executive said. "We have not had rational pricing or underwriting criteria for the last 12 months. The trend of rising early payment defaults was evident for some time and we should have raised our rates in response but we did not because we were afraid our competition wouldn't do the same." The challenge now, he added, is in "finding the right balance" between underwriting guidelines and volume.

"Getting everything aligned properly is complicated, but I feel very good about the future," Mr. Nadon said. "We now have a much higher-quality product, a nice balance between cost and price and we are getting back to normal. In the short term, the market is going to get worse, not better. But I think the next two to five years will be terrific."

Mr. McQuiggan, on the other hand, wasn't so optimistic, especially about the future of mono-line companies, which he predicted would not survive the extreme falloff in volumes unless they were attached to deep-pocket parents.

"We will continue to see the loss of major companies over the next 90 days if they don't have liquidity," he ventured. He also said that companies, which got caught up in the five worst words in business - everybody else is doing it - will pay a heavy price for their irrational behavior. "A lot of companies are not going to live to see another day, and they can't get upset at anybody but themselves," he said.

Both industry leaders also prophesied that nontraditional loan products will remain in vogue in one way or the other despite the current negative publicity that surrounds the mortgages. "At one time, ARMs were not traditional," Mr. Nadon said. "There's nothing wrong with the option ARM. The problem is with the definition."

Mr. McQuiggan said it might best serve the lending community to move away from loans with rates that remain fixed for two or three years and then switch to one-year ARMs. He suggested a five-year fixed-rate timeframe might be better, if only so it does not appear that originators are "not constantly trying to churn our portfolios."

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