Subprime loans were only part of what led to the housing market crash. Here are several contributing factors and the changes they spurred in the mortgage industry:
1. Low-doc loans: The rise of the self-employed after the recession of the later 1990s helped fuel the onslaught of borrowers qualifying for low-doc loans.
As the market tightened, providing little to no documentation of income to obtain a loan all but went away. As the self-employed had to participate in a more stringent review of their loan applications, it was tougher for borrowers to qualify for loans, and that resulted in some homeowners being unable to refinance. Further crippling their chances for a refinance was the same issue traditional loan borrowers faced: As homes lost value, they lost equity.
2. Adjustable-rate mortgages: More than $750 billion of option ARMs were originated in the U.S. from 2004 to 2008, according to Inside Mortgage Finance of Bethesda. ARMs are not going away, as many home buyers see the benefit of them in terms of initial lower interest rates and low monthly payments for their loans.
3. Equity line of credit: As median home values rose rapidly throughout the nation in the early 2000s, many homeowners used their homes as ATMs to withdraw equity to build decks or remodel kitchens, buy a car or finance a luxury vacation or tend to medical bills or other debt.
But once the values started to sink, home buyers couldn’t pay off these second loans, not even if they put their houses on the market. The homes were appraising at less than what was owed on them, so many lenders began to reduce the amount of credit that could be extended, or did away with the programs altogether.
4. More money down needed: FHA-backed loans can require only 3.5 percent down, that’s up from the 3 percent required in the boom years. But that still very low minimum has now increased to 10 percent down for borrowers with a credit score of 580 or lower. (Finding a lender willing to lend money to someone with a score below 640 is already an uphill battle.)
For prospective buyers with poor credit or little savings, this seems to put homeownership almost out of reach, especially when you consider that the government also stopped seller-funded down payment assistance in 2008. In today’s market of multiple offers, it seems unlikely that a seller would choose a buyer who needed financial help, but paying points for a buyer to reduce the interest rate or closing cost is still legal and some buyers negotiate it into their contracts.
5. Mortgage insurance: It used to be that homeowners could put 20 percent down on an FHA-backed mortgage and avoid paying mortgage insurance. Or if over time the borrower reached 20 percent equity in the home, the mortgage insurance could be canceled. But with the rate of defaults on loans, FHA felt compelled to change the rules.
Since June, FHA-backed loans now require mortgage insurance for the life of the loan.