Many folks have tried to lay the blame for the subprime mortgage meltdown which could plunge the nations real estate market into a decade long decline on unrestrained or crooked mortgage brokers. However, the mortgage brokers could only sell what the subprime lenders created. So do you blame the monster or Dr. Frankenstein himself?

In this analogy, the subprime or bad credit mortgage lender is Dr. Frankenstein. They created the risky programs, approved the loans, and provided the money at closing, and sold them to the secondary market investors. The monster is born and set loose.

But there’s more to the story…

A bad credit lender lends their money to you. After that, your loan along with others like it are bundled up and sold to an investor. The lender doesn’t have endless supplies of cash so they need the investors to buy the loans they close. This way their money is replenished to lend out again and they make a profit from selling the loans to the investor. It’s the same thing that happens in the traditional or “A paper” mortgage world.

The only difference is you have a couple of organizations called Fannie Mae and Freddie Mac governing the A paper world. They make the rules on how loans get approved and priced. If the “A” lender follows the rules, the loan gets an insurance certificate. The investor buys the insured loan. If the loan goes into default, the investor is not out their money. Since the loan is insured, Fannie or Freddie pays the final investor for the defaulted loan. A bad credit mortgage lender does not have any insurance for the final investor. If the loan goes into default, the final investor has no recourse. They just lose money. So with this added risk, the bad credit investor wants higher rates to justify the investment. The lust for higher and higher rates of return is real driving force for the subprime market.

So who really makes the rules for bad credit mortgages? The investors themselves do. The investor decides how much risk they will take, what rate is acceptable, and what kinds of loans they will buy. If the lender doesn’t underwrite and approve the loans using the final investor’s rules, the investor won’t buy the loans. Then, the lender is stuck with the loans and won’t have as much money to lend out.

The investor is always changing the rules depending on what’s happening in the market. Currently, foreclosures are going crazy. You would have to be living under a rock not to know. Because so many of the mortgages in foreclosure are bad credit mortgages, the investors are changing their underwriting rules. Remember, the investors don’t have an insurance policy to fall back on. They are stuck with the loss themselves. In order to cover some of their losses, they are changing the rules. The investors want some extra equity if the loan goes into default. Right now they require the lender to get a review appraisal or a BPO (broker price opinion) letter. A BPO is simply an agent giving his or her opinion of what your house is worth. And guess what…the review and the BPO almost always come in lower than your appraisal. When this happens, you need to bring more money to closing, get less cash out, or get denied all together.

The bad credit mortgage lender lends money to folks with credit issues but that’s all they do. As soon as they close your loan, it gets sold to the investor. They have to follow the final investor’s rules.

So, hold the phone…does that mean Dr. Frankenstein build the monster at the behest of others? Sure it does…so the greedy final investors must also share the blame with the subprime lenders.

As in all things in this industry, most of the story is hidden from view.

But not for you… now that you know the “inside” story about the subprime lenders, final subprime investors, and how they let a monster loose to destroy our village.

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