The Return of Subprime Mortgages

The 2008 crisis in America was mainly caused by making subprime housing loans. The crisis first gripped some cities in America and then finally overtook all of America. Since many other countries invest in American securities, the crisis became global in nature and threatened to sink the world economy.

At that moment, it seemed like the banks had learnt their lesson. It was fairly obvious that the crisis occurred because banks allowed broke people to take out hefty mortgages. The critics, as well as the government, were flabbergasted with the irresponsibility shown by the financial sector. It seemed like since the subprime mortgage crisis wiped out many iconic American banks, this risky asset class would never again surface in the market.

However, now in 2018, we can confirm that the predictions were not accurate. Barely a decade after subprime loans wreaked havoc in global markets, they are back with a bang. According to news reports by Forbes and CNN, Bank of America which is the largest bank in America is making subprime loans to thousands of borrowers. To an external observer, it seems like the banks have once again started making risky and irresponsible bets. However, if Bank of America is to be believed, this is not the case.

In this article, we will have a closer look at the return of subprime mortgages and the actions being taken by Bank of America to prevent a repeat of the 2008 fiasco.

The Revamped Subprime Mortgage Program

Bank of America does not agree that it is making subprime loans once again. Instead, bank official claims that they are making loans to borrowers who fail to obtain credit when traditional methods are used to evaluate their application. Bank of America also believes that since a lot of these borrowers tend to be from minority communities, this program, in fact, helps them to meet their social responsibility.

Bank of America states that the only similarity between 2008 loans and the present loans is that in both cases mortgages have been issued to borrowers with zero down payments. Bank of America, however, believes that there are a lot of other factors which make the present loans more responsible and less predatory in nature.

Some of the measures being taken by Bank of America to ensure the quality of the loans that they make are as follows:

Not Speculative: Prior to the 2008 crisis, banks were making loans to just about anybody who had a credit score. Not only did banks not ask for any down payments, but the banks also ended up lending money for speculative purposes.

Bank of America is determined not to repeat this mistake. This is the reason why Bank of America is only making subprime loans to people who are planning to live in the house that they purchase.

The bank is not funding people who want to make wild bets on the real estate market by buying second and third homes that they clearly cannot afford. Also, the subprime loans are not being made to people without jobs. The down payment requirement is waived off for the borrower. However, they still have to demonstrate their ability to earn a steady income either by furnishing their pay slips or their bank statements.

Counseling: Bank of America also claims that a lot of foreclosures that happened last time were because of the lack of education. People working in the financial services industry were mis-selling mortgages to unsuspecting people. This is because they were providing fixed interest rates upfront. However, the borrowers were not informed about how the payments will change if the interest rates rise.

Bank of America is ensuring that this mistake is not repeated. Bank of America now only provides loans to people after having a look at their monthly budget. Common incidents which stress financial budgets such as medical issues and job losses are also taken into account.

The borrowers are explicitly made to understand that the interest rates associated with the loans could change in the long run. The impact of these increased payments on their monthly budgets is also discussed with the borrowers.

Simply put, the borrowers are mentally prepared for financial challenges that they might face if market realities change. The last time, borrowers simply fled the market. Bank of America is hoping to stop the exodus this time and believes that counseling will play a major role.

Character-Based Lending: Lastly, Bank of America has come up with a new lending system called character-based lending. Under this system, borrowers are not held accountable for events beyond their control.

For instance, medical debt is not considered while making mortgage loans. The bank also looks at the financial discipline that the borrower is following. For this, a record of past payments made is carefully scrutinized. Lastly, borrowers have to demonstrate that they can save money in their current budget before a loan is actually made.

Since the process of vetting individuals for loans now requires a lot of work, Bank of America is partnering with a broker called Neighborhood Assistance Corporation of America (NACA). Also, to cover the increased costs of making these loans, NACA pays Bank of America 33% of the brokerage that they make by selling the house.

All being said and done, the mortgage loans being made are still risky business. If the market value of the houses were to fall drastically, these subprime loans could once again lead to cascading defaults. However, this time the quantum of these loans is much less, and hence they are unlikely to cause a catastrophe.

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