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Call It A Comeback For Risky Home Buyers
More Americans who recently went through foreclosure or bankruptcy are getting home loans.
A new wave of nonbank lenders is bringing these risky buyers back into the housing market some seven years after the mortgage meltdown. The lenders are targeting borrowers who have recently gone through a foreclosure, short sale or bankruptcy—but who they say are safer than their credit profiles suggest. They are sometimes approving borrowers in as little as a few months or even weeks after a foreclosure.
“Lenders are trying to carve out niches that play upon the fact that underwriting remains, by historic standards, very tight,” said Guy Cecala, publisher of Inside Mortgage Finance, a trade publication. “That’s always the way it starts out and then you keep loosening and loosening—we’re right at the beginning of that.”
Several lenders have entered this market since the housing crisis, and their numbers, while still small, have picked up over the past year. Mr. Cecala estimates that mortgage originations for borrowers who have recently been through a major financial setback and are back on their feet will total at least $5 billion this year. That’s up from around $2 billion to $3 billion last year and expected to be the highest since the housing boom, he said. That compares to a total of $1.3 trillion of mortgage originations that are expected for 2015, according to the Mortgage Bankers Association.
The move represents a growing appetite for riskier borrowers—and a possible turning point in the mortgage industry in which more lenders are willing to experiment with looser lending standards. Most large lenders don’t make such mortgages.
The lenders could be exposing themselves to future losses. In many cases, these mortgages fall outside of the Consumer Financial Protection Bureau’s “qualified mortgage” definition, which went into effect last year.
Such mortgages require a borrower’s monthly debt to remain under a certain threshold compared with their income, and require that loan fees and interest rates don’t exceed a certain level, among other criteria. Lenders that give out nonqualified mortgages are at greater risk of being sued by borrowers who default and claim that the lender didn’t adequately confirm they could afford the loan.
Lenders, for their part, say they review applicants’ income to ensure they have the means to take on the mortgage and require down payments that are often north of 25%. They also check credit reports to make sure these borrowers are paying their bills on time—and for evidence that their previous credit blemishes were due to a one-time event, such as a job loss or other hardship.
Lenders can charge such borrowers higher interest rates—often ranging from 5% to 10%.
“We think there is a good credit risk in a certain select group of those people,” said Jerry Schiano, president of New Penn Financial LLC, a mortgage lender based in Plymouth Meeting, Pa., and a subsidiary of finance company Shellpoint Partners LLC. “A life event shouldn’t define the person forever, and they should have a chance to improve themselves if they have appropriate income and reserves.”
New Penn in October began giving out mortgages to borrowers with a completed foreclosure, short sale or bankruptcy as recently as a year earlier. The lender, which requires a minimum 620 FICO score, on a scale that ranges from 300 to 850, has originated more than 100 of these loans since the beginning of the year, totaling about $50 million.
Some lenders say they will approve borrowers with subprime FICO scores—as low as around 500—but in many cases, borrowers have good credit scores despite still having a negative event on their credit reports. A foreclosure may have lowered their score by up to 200 points, said John Ulzheimer, president of consumer education at CreditSesame.com, a credit-management site. But that could still leave them with a decent credit score if they had a score in the high 700s or 800s before the event.
Data from FICO show that some borrowers can recover quickly if they don’t fall behind on any other debts or suffer other missteps.
The loans are often funded by or sold to private-equity firms, hedge funds and other investors who are seeking investments with higher yields and are prepared to take on more risk. Annual yields can range from 8% to 18%. Some lenders are holding the loans on their books with plans to eventually securitize them.
Malcolm Davies, a 39-year-old partner at a commercial real-estate investment banking firm, filed for personal bankruptcy in 2009 after he was unable to pay back construction loans on office buildings and other investment properties he was developing when the real-estate market crashed. Two condominiums owned by Mr. Davies also went into foreclosure, a process that was completed in 2011.
As Mr. Davies’s career and finances recovered and he and his wife had three children, he began to think about buying a home. The bankruptcy and foreclosures remained on his credit reports, but his FICO scores had rebounded up to the low 700s.
Last month, the Davieses closed on a $2.83 million home in Manhattan Beach, Calif., after making a 30% down payment. They received the mortgage from Encinitas, Calif.-based lender Drop Mortgage, which launched last year and works mostly with applicants who have had a foreclosure or short sale.
‘This is the highest response we’ve gotten from borrowers and realtors inquiring about the program from anything [else] we’ve done.’
—Mark Dodson, president of Mortgage Capital Advisors
Their interest rate is 4.375% on an adjustable-rate mortgage, which will reset in five years—nearly 1.5 percentage points higher than the average rate at the time, according to mortgage-information website HSH.com.
Drop Mortgage has given out $96 million in mortgages since July, said its president, Jon Maddux. It has no minimum FICO score requirement but prefers borrowers above 600.
Atlanta-based Angel Oak Home Loans LLC offers mortgages as little as one day after a foreclosure. The lender, which began giving out these loans in 2013, sells some of them to a hedge fund managed by sister firm Angel Oak Capital Advisors LLC, an investment-management firm with about $5 billion in assets under management, said Whitney Fite, president of Angel Oak Home Loans. The hedge fund is currently holding more than $25 million of these mortgages.
Mortgage Capital Advisors, a mortgage broker based in Atlanta, began giving mortgages to people recently out of short sale, foreclosure and bankruptcy earlier this year. The firm sent a flier about the loans this month. “This is the highest response we’ve gotten from borrowers and realtors inquiring about the program from anything [else] we’ve done,” said Mark Dodson, president.