There are several things that caused the subprime implosion, but here we try to lay out what is happening from a mortgage lender’s perspective and explain why it is so hard to get loans right now (and thus refinance out of a risky mortgage). This also explains why SO MANY lenders have gone out of business in the current market. (List of Lenders that have closed at the bottom.)

What is a SubPrime Loan and what is a SubPrime Borrower?

First, we need an acceptable definition of exactly what is meant by a "subprime loan." As you’ll see in the following paragraphs, even this concept is hard to accurately pinpoint.

Let’s start by defining an easy concept: the SubPrime Borrower.

SubPrime Borrowers are borrowers who have less than perfect credit and have correspondingly lower FICO scores (FICO scores are arbitrary scores assigned by the Credit Reporting Agencies). The reason SubPrime loans exist is to help people who have less than perfect credit purchase homes. People who have blemishes on their credit are more likely to miss a payment, pay late, etc. and therefore are charged a higher rate on their mortgage.

SubPrime Loans are loans that were made to SubPrime Borrowers that carried a higher rate than loans given to borrowers with perfect credit. The "Prime Rate" (for Mortgage purposes) is considered to be the best available rate for a given product. The first definition then is: A SubPrime loan then is ANY LOAN that had an interest rate less than the best available rate at the time it was originated.

Definition of "SubPrime"

I used "first definition" because there are other categories of loans that are considered SubPrime as well. Some loans didn’t require Full Documentation and thus were more risky – even when made to borrowers with good credit – because you couldn’t ascertain the borrower’s ability to repay as precisely as with Full Documentation loans. Full Documentation means Tax Returns, Current Pay Stubs, References, Bank Statements, etc... Borrowers who have seasonal or home businesses often utilized these loans. The second definition of a SubPrime loan is then: SubPrime loans also include loans that were made with less than Full Documentation at the time they were originated.

Lenders are often categorized based on the type of loans they make:

• "A" Paper Lenders only do loans to those with good credit and charged relatively low rates.
• "Alt-A" Lenders/ SubPrime Lenders do loans to those with slightly imperfect credit. These loans have somewhat higher rates and oftentimes have other negative aspects such as prepayment penalties.
• Hard Money Lenders do loans to those who desperately need money and have bad credit. (Think LoanShark!)

Lenders do not Service (or hold onto) the loans they originate (sometimes they do, but not often). In other words, the entity that makes the loan is not the entity that will be receiving the payments from borrower. The Lenders bundle the loans into a pool of loans and sell them on the back end to investors. The loans are pooled together based on common characteristics and generally follow the same categories as the lender categories above. Here’s what you need to understand:

Risky Mortgages

From an Investor’s perspective, buying a pool of loans is very much like buying a car. The investor and lender agree on a price. The two most important things to understand are: (1) The price is based on the perceived value of the pool and (2) The lender gives the investor a warranty very much like a car warranty – these loans will work (conform to certain guidelines) or we will buy them back.

Let’s examine the PERCEIVED VALUE of these loan pools:

• A Paper loans have been around for forever and have easily determinable characteristics – they don’t default much – they pay on time – but the interest rates are low. There isn’t much risk, but they don’t have the potential to make much money either.
• SubPrime loans are relatively new and often difficult to understand. The default rates are higher, but the interest rates are higher and they usually carry prepayment penalties.

The beginning of the problem occurred when investors perceived some of these SubPrime loans to be worth substantially more than the regular A Paper loans. From a pure math perspective – and assuming the borrowers pay on time and do not default – these loans are worth MUCH MORE because of the higher rate and the prepayment penalty.

To make it simple, let’s say that a $100 loan actually appeared to be worth $110 dollars. The investor planned on getting more than the $10 spread by cashing in on the higher than market rate interest rate. Meanwhile, that incremental $10 made it worthwhile for lenders to keep pumping these loans out.

Hard to Refinance

From a Lender’s perspective, the money appeared to be in SubPrime lending. Everyone involved simply made more money – brokers, real estate agents, etc. (Keep in mind that borrower’s can pay more when using loan products other than the traditional 30 year fixed). As it became evident that they could make more money by selling investors these SubPrime loans, more and more SubPrime loans began being created and sold to borrowers.

The Implosion started when Investors began figuring out that they paid way too much for these SubPrime loans. These loans defaulted much more than expected (because of the very terms of the loans themselves!) and instead of the $100 loan being worth $110, the investors realized that these loans were actually worth $95. They immediately stopped buying them (Problem #1) and they began making the lenders buy back the loans that had problems under the warranty (Problem #2).

Lenders could no longer sell the loans they had already originated, so they were forced to keep them on their books and service them (and remember, these were money losing loans to begin with) AND they were forced to buy back loans that they had warrantied. The result: CLOSE UP SHOP! (See List Below).

The Fallout for SubPrime Borrowers

Borrowers who fell into the SubPrime category described above were often promised that they could simply "refi out" of their loan in a couple of years with the same type of loan and continue the cycle. Unfortunately, these loans are simply not available and the borrowers are now being forced into foreclosure.

Mortgage Lenders that Have Ceased Operations since 2006:

ApexMortgage(ApexFinancialGroup)
AccreditedHomeLenders,HomeFundsDirect
AcousticHomeLoans
ACTMortgage
Aegis
AleraFinancial(Wholesale)
AllFundMortgage
AllianceBancorp
AllianceMortgageBankingCorp(AMBC)
AllstateHomeLoans/AllstateFunding
AlternaMortgage
AlternativeFinancingCorp(AFC)Wholesale
AltivusFinancial
AMCLending
AmericanHomeMortgage/AmericanBrokersConduit
Ameriquest,ACCWholesale
AmeritrustMortgageCompany(SubprimeWholesale)
AmstarMortgageCorp
AxisMortgage&Investments
BankofAmerica(Wholesale)
BNCMortgage(Lehman)
BridgeCapitalCorporation
BrokerSource(BSMFinancial-Wholesale)
BrooksAmericaMortgageCorp.
Bryco(Wholesale)
C&GFinancial
CalusaInvestments
CapitalSixFunding
CastlePointMortgage
CFICHomeMortgage
ChevyChaseBankCorrespondent
ChoiceCapitalFunding
CITHomeLending
CitimortgageCorrespondent(2nds)
ClearChoiceFinancial/BayCapital
CoastalCapital
ColumbiaHomeLoans,LLC
ConcordeAcceptance
ConcordMortgageWholesale
CoreStarFinancialGroup
CountrywideSpecialtyLending
DanaCapitalGroup
DecisionOne(HSBC)
DeepGreenFinancial
DeutscheBankCorrespondentLendingGroup(CLG)
DiabloFundingGroupInc.
DollarMortgageCorporation
DomesticBank(WholesaleLendingDivision)
EagleFirstMortgage
ECCCapital/EncoreCredit
EdgewaterLendingGroup
EntrustMortgage
EquiBanc
EquiFirst
EquityFundingGroup
E-TradeWholesaleLending
ExchangeFinancial(Wholesale)
ExpandedMortgageCreditWholesale
ExpressCapitalLending
FieldstoneMortgageCompany
FirstBankMortgage
FirstConsolidated(SubprimeWholesale)
FirstHorizonSubprime,EquityLending
FirstIndianaWholesale
FirstMagnus
FirstMarinerWholesale
FirstNationalBankofArizona(FNBA)Wholesale,Correspondent
FirstSourceFundingGroup(FSFG)
FirstStreetFinancial
FlexPointFunding(Wholesale&Retail)
FlickMortgage/MortgageSimple
FMFCapitalLLC
Foxtons,Inc.
FreestandFinancial
FremontGeneralCorporation
FundingAmerica
GEMLoans/PacificAmericanMortgage(PAMCO)
GreenPointMortgage-CapitalOneWholesale
GroupOneLending
H&RBlockMortgage
HarbourtonMortgageInvestmentCorporation
HeartwellMortgage
HeritagePlazaMortgage
Home123Mortgage
HomeBancMortgageCorporation
HomeCapital,Inc.
HomeEquityofAmerica
HomefieldFinancial
HomelandCapitalGroup
HomeLoanSpecialists(HLS)
HonorStateBank
HorizonBankWholesaleLendingGroup
HSBCMortgageServices(correspondentdiv.)
ImpacLendingGroup(Wholesale)
InnovativeMortgageCapital
InvestaidCorp.
IvanhoeMortgage/CentralPacificMortgage
KellnerMortgageInvestments
KirkwoodFinancialCorporation
LancasterMortgageBank(LMB)
Lender'sDirectCapitalCorporation(wholesaledivision)
LexingtonLending
LibertyAmericanMortgage
LoanCity
LongBeach(WaMuWarehouse/Correspondent)
LowerMyPayment.com
LownHomeFinancial
MadisonEquityLoans
MandalayMortgage
MaribellaMortgage
MasterFinancial
MercantileMortgage
MeritageMortgage
MeritFinancial
MILA
MilleniumBankshares(MortgageSubsidiaries)
MilleniumFundingGroup
MLN
MLSG
MortgageInvestorsGroup(MIG)-Wholesale
MortgageIT-DB(Retail)
MortgageTreeLending
MylorFinancial
NationalCity-HomeEquity,Correspondent
NationOneMortgage
NationsHomeLending
NationstarMortgage
NetBankFunding,MarketStreetMortgage
NewCenturyFinancialCorp.
NewStateMortgageCompany
NoRedTapeMortgage
NovaStar(Wholesale),HomeviewLending
OakStreetMortgage
Opteum(Wholesale,Conduit)
OptimaFunding
OrigenWholesaleLending
OwnItMortgage
ParagonHomeLending
People'sChoiceFinancialCorp.
People'sMortgage
PlatinumCapitalGroup(Wholesale)
PopularFinancialHoldings
PreferredAdvantage
PremierMortgageFunding
PremiumFundingCorp
PriorityFundingMortgageBankers
Pro30Funding
QualityHomeLoans
QuickLoanFunding
ResMAEMortgageCorp.
Right-AwayMortgage
RoseMortgage
SCMEMortageBankers(Wholesale)
SeaBreezeFinancialServices
SebringCapitalPartners
SecuredFunding
SilverStateMortgage
SolutionsFunding
SouthernStarMortgage(Wholesale)
SouthStarFunding
SovereignBancorp(WholesaleOps)
SpectrumFinancialGroup
StarpointeMortgage
StewardFinancial
StoneCreekFunding
SummitMortgage
SummitMortgageCompany
SunsetDirectLending
SunsetMortgage
TheLendingConnection
TheLendingGroup(TLG)
TheMortgageStoreFinancial
TheMortgageWarehouse
TransnationalFinanceWholesale
TrojanLending(Wholesale)
TrumpMortgage
UBSHomeFinance
UnlimitedLoanResources(ULR)
ValleyVistaMortgage
WachoviaMortgage(Correspondentdiv.)
WarehouseUSA
WellsFargo(variousCorrespondentandNon-primedivisions)
WinstarMortgage
WMC
ZoneFunding