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D. Sidney Potter Headshot

Is Non-Prime the New Sub-Prime?

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With the recent Academy Award winner for best movie of the year going to 12 Years a Slave, it was only topical to quote a former slave owner himself, Thomas Jefferson, who stated the following as it relates to real estate and the banking system: "And I sincerely believe... that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale."

It's fitting that a former slave owner would understand the real underpinnings of banking with such exactness, but Thomas Jefferson actually got it right. Which is ironic, given that both institutions, wherein one is extinct, were formulated on the exploitation of people, one physically and the other economically.

Fast forward. It's nearly unanimous amongst many real estate professionals -- including yours truly, that something has to give in the real estate mortgage industry in order to create more fluidity in the lending markets. This is especially so, for everyday individuals who wish to buy a home or an investment property.

Underwriting -- With Your Gut

As an example of those industry professionals that are bucking the trend, take Bill Dallas, whose previous two sub-prime mortgage companies went bankrupt during the most recent real estate meltdown. Before the crash, Mr. Dallas sold First Franklin Financial Corp to Merrill Lynch in 2006 for $1.3 billion. The new company from Mr. Dallas, NewLeaf Lending in Calabasas, California, is offering sub-prime loans under the banner of non-prime. "You're going to have to make all types of loans, ones that conform to all the new standards and ones that don't, to keep powering the housing recovery," said Mr. Dallas, "There needs to be a solution for people who don't fit in the box, and rebuilding non-prime lending is it."

Non-prime is a sort of "new and improved" sub-prime loan, without the bitter aftertaste. In fairness to Mr. Dallas and other mortgage executives like him, this newly re-formatted loan product is a sincere and much needed noble effort to resuscitate the unconventional loan market, which in this case is a re-vamped sub-prime product. If you were to graph the mortgage product market that non-prime loans fall under, this product type would tumble somewhere between prime loans -- which average about a 4.5 percent interest rate today, and hard money loans -- which average about 13 to 18 percent in today's market. The interest rate range for non-prime loans -- which are sometimes called Alt-A, where the 'Alt' stands for alternative, is anywhere between 6 to 13 percent, on a 30-year fixed rate.

Street Legal Loans

Think of non-prime loans as the antecedent to street legal loans. Whereas Alt-A is a niche below prime loans and can usually be securitized on Wall Street because it conforms to generally prescribed underwriting guidelines, non-prime will never see the light of day on Wall Street, despite its appeal to Main Street. These loans will fail an emissions test and consider speed odometers passé. Non-prime, metaphorically speaking, is the loan type mothers tell their daughters to stay away from. Non-prime loans, which require the borrower to put more down on the purchase of a primary home (20 to 30 percent), and can be executed with a FICO score in the 500 to 550 range, a prime loan may require a FICO score in the 720 range with only 5 to 10 percent down

The real good news for those wanting to buy a rental, is that non-prime loans require only 20 percent down with a FICO score in the 680 range. The real kicker however, is that income documentation requirements are substantially more lenient. In addition to being more forgiving for past transgressions (think foreclosure, bankruptcy and mortgage lates), non-prime will yield to higher debt ratios for an individual. Players in this market include Citadel Loans, Athas Capital Group and IMPAC. On the opposite spectrum, prime loans usually require 30 percent down with about a 740+ FICO score for an investment property.

Smart money incidentally goes to HomePath.com and HomeSteps.com. These government websites are fully functional (take note Affordable Care Act website). Administered by Fannie Mae and Freddie Mac, respectively, these websites/government REO sites only require borrowers to provide 10 percent down on investment property for single family homes and condos. Minimum FICO requirements are in the 650 range.

Despite Mr. Jefferson's disdain in paying the minimum wage, he was clearly prescient in calling out the U.S. real estate market and its relation to the banking industry:

"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered."