A Bad Credit Mortgage Solution: Another Bad Credit Mortgage?

Owners who bought a home with a bad credit mortgage loan, and now face foreclosure because they cannot make their payments, may have an unlikely remedy: get another bad credit mortgage loan.

The interest rates on as much as $1.5 trillion worth of adjustable-rate mortgages could rise this year, increasing the monthly payments for borrowers.

Paying off an old subprime loan with a new mortgage with similar monthly payments, but changes in other terms, is one of the few options many borrowers may have to avoid foreclosure, according to industry sources.

While not a long-term fix, such subprime loans can be a stopgap measure that lets a borrower cut payments and repair their credit score.

However, rising delinquencies have resulted in falling lending volumes in the subprime mortgage market for less creditworthy borrowers, while regulators have threatened to forbid certain mortgage loan products.

This could leave many subprime borrowers stranded with no financing options if their mortgage interest rates reset at higher levels and become unaffordable, said Patrice Yamato, president of the Florida Association of Mortgage Brokers.

“If regulators come in and disallow subprime lending, we are going to end up seeing more foreclosures because these people just can’t get another loan,” she said.

While the reputation of subprime mortgages has been tarnished by the media, and their popularity has waned in financial markets, some still tout their virtues. Many subprime borrowers financed their homes with a so called “2-28″ mortgage that requires low payments in the first two years of its thirty-year maturity.

Homeowners who make regular payments on such a subprime mortgage may graduate to the better terms of prime rate loans.

Investors have soured on securitized subprime mortgages in recent months, though, and regulators could deal those products a deadly blow with tough new guidelines, said Doug Duncan, chief economist with the Mortgage Bankers Association.

“If you eliminate these products - one of the tools that they use to manage the transition (out of subprime) - then you reduce the probability of them making the transition,” Duncan said.

About half of subprime borrowers who bought a home in the last five years and then mortgage refinance, move up to prime terms, Duncan said, citing a straw poll of mortgage servicers.

However, some consumer groups argue that troubled subprime borrowers need stronger medicine than a fresh subprime loan.

“Making them another bad loan is not in any way helping them,” said Debbie Goldstein, vice president of the Center for Responsible Lending (CRL).

One in five subprime mortgages made in 2005 and 2006 will end in foreclosure, predicts the North Carolina advocacy and research group.

Mortgage refinancing into a new subprime loan “is going to do more damage and prolong the inevitable - which is foreclosure for most people,” Goldstein said.

The only way to battle those odds are with a truly stable mortgage that has a fixed interest rate, lower principal repayments, and a longer maturity, or other favorable terms, Goldstein said.

The mortgage industry exaggerates the number of subprime borrowers who grow into better mortgage terms, Goldstein said, pointing to CRL’s own research showing that three-quarters of subprime borrowers refinance into another costly subprime loan.

But debating the virtues of refinancing into another subprime loans may be academic, said Patrice Yamato, since funding for high-risk home mortgages has evaporated. The homeowner with a poor credit history, little money down, or little proof of income, cannot get the same financing that they could even several months ago, she said.

“Subprime lenders have tightened up so much that a lot of those subprime loans are not getting made,” she said, so many homeowners are just going to have to brace for a payment shock or contemplate giving up their homes.