For Mortgage Market, It Is Time for Prime

The meltdown in the subprime mortgage market is making it tough for many potential home buyers to find financing. Home buyers with damaged or thin credit histories may be shut out.

But what about people with the best credit? Will the problems in subprime have any impact on how costly or easy it is to get mortgages for so-called prime borrowers?

Jay Brinkmann, economist for the Mortgage Bankers Association, says subprime problems may "bleed over" into prime.

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As evidence of this he cites "a general increase in credit spreads across the board." When the supply of money for loans falls, credit spreads - the difference between what lenders pay in interest versus what they get from borrowers - tend to rise, making all loans more expensive, including prime.

What a difference a year makes.

In 2004, 2005 and through early 2006, housing was still hot and home loans of all kinds were easy to come by. Investors were pumping money into the mortgage markets and they were willing to buy riskier loans in return for high yields; sometimes, it now seems clear, the risks were over the top.

"Investors signaled that they willing to buy some stupid loans, so mortgage brokers went out and wrote some stupid loans," says Randy Johnson, president of Independence Mortgage Co. and author of "How to Save Thousands of Dollars on your Mortgage."

For years, gains of 10 percent or more in home prices had insulated lenders from their mistakes; owners could keep up payments by tapping their growing home equity. Or they could sell at a profit.

That changed when price appreciation finally slowed to more normal levels. And now, banks have become much more cautious, and much more likely to turn down borrowers with marginal credit scores.

Plus, the subprime lending industry itself is undergoing a shake-out with many lenders exiting the scene. Because of stiff losses from non-performing loans, more than 20 have either already closed their doors or are scrambling to find added financial backing. Fewer industry players will also dry up some liquidity.

Fewer apply for mortgages

Meanwhile, late last month Freddie Mac announced more restrictive standards for subprime mortgages. It will no longer buy "hybrid" adjustable-rate loans that will have a high likelihood of failure when their rates reset at much higher rates later. This is likely to further restrict the source of funds for subprime loans.

And others are following Freddie Mac's lead by scrutinizing applicants more carefully.

At a Senate Banking Committee hearing last Thursday, Laurent Bossard, CEO of WMC Mortgage, said his company has made many improvements over the past 12 months to reduce subprime loan risk, including restricting subprime hybrid ARM loans to those borrowers the bank judges are able to make payments based on higher reset rates rather than the initial low "teaser" rates.

Other lenders, such as Countrywide Financial and First Franklin, have also pledged to maintain high underwriting standards.

All these factors will make it much harder for borrowers with damaged or thin credit histories to qualify for loans.

For prime borrowers, the picture is less clear, though most likely few will have trouble finding a loan. But will the terms be as favorable?

Rates fall

According to Patrick Newport, an economist with Global Insight, a provider of financial news coverage and analysis, the subprime crisis has had little negative impact on prime markets.

"If you look at the 30-year fixed, rates have been dropping," he said. "I'm surprised that the 30-year rates have not edged up and it's probably because subprime problems don't affect most borrowers."

Some think the effect on prime could even be positive.

"The fall-off in subprime originations could add to the liquidity of prime markets," said Keith Gumbinger of financial publisher HSH Associates, which tracks the mortgage industry.

The banks and other investors who were big buyers of mortgage-backed securities may be more likely to look for higher-quality investments now, in other words, securities backed by prime lending, increasing the stream of dollars going there.

"[Prime borrowers] could enjoy a little bit more attention now with even more lenders competing for their business," says Gumbinger. "The drive into prime could compress profit margins and lead to better rates and lower fees. It could also mean higher levels of service."

Home ownership will drop

But the biggest impact of the subprime crisis will undoubtedly be on home prices. Because fewer Americans will be able to obtain financing, fewer will be in the market for homes.

And, the number of people losing their homes through foreclosure or forced sale will also add to the housing market supply. Prices, already stagnant or falling in many areas, will face more downward pressure from increased inventories.

The bottom line is that, for solvent home buyers at least, the next several months look very bright. Lenders will be competing more for their business; low mortgage rates are unlikely to go up; and home prices in many areas will go down.

The subprime crisis could be that proverbial ill wind that blows some good. It may produce some of the best conditions for home buyers in a while.

But only if their credit is in prime condition.