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Wow, I could've had a prime mortgage

Why many borrowers who qualified for prime-rate loans wound up with subprimes instead.

Les Christie, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- Imagine you're a homeowner, and you discover that instead of the expensive subprime mortgage loan you signed on for, you actually qualified for a prime mortgage with much lower interest rates.

Subprime loans are usually designed for borrowers with damaged or sketchy credit histories. Lenders charge higher rates to these customers to offset the extra risks they take on. Prime loans are usually granted to borrowers with credit scores of 650 or higher.

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How your credit score affects your mortgage rate
For a $300,000 30-year fixed-rate loan
FICO score APR Monthly payment
760-850 5.860% $1,772
700-759 6.082% $1,814
660-699 6.366% $1,870
620-659 7.176% $2,031
580-619 8.820% $2,375
500-579 9.679% $2,562
Source:Source: myFICO.com; rates as of May 7, 2007

The extra interest can total 3 percentage points or more, which would add $300 to monthly mortgage payments on a $200,000 loan. And some industry insiders say you may be paying higher rates when you don't have to.

"I reviewed several hundred [subprime] loans recently for our wholesale division," said Allen Hardester, regional director of development for mortgage-broker, Guaranteed Rate, "and all of them, with one exception, qualified for a prime-rate loan."

Freddie Mac, a government-sponsored mortgage-loan buyer, estimated that borrowers of 15 to 35 percent of all subprime loans it bought in 2005 could have qualified for prime-rate loans.

Fannie Mae, another government-sponsored loan buyer, estimated up to 50 percent of the borrowers, whose subprimes it bought that year, had credit profiles that could have qualified them for prime rates.

No one to blame but yourself

Perhaps the biggest culprit is simply that many consumers don't know enough about mortgages to question the deals they're offered.

Doug Duncan, chief economist for the Mortgage Bankers Association, said a 1999 MBA survey revealed that 31 percent of all home buyers never spoke to anyone except their real estate agent when they bought a home.

The survey needs to be updated, he said, but it still suggests that many consumers enter some of the biggest financial deals of their lives with their eyes wide shut.

"People take things too nonchalantly," said Hardester. "If you've got plenty of money and don't mind not getting the best rate, listen to your realtor."

Follow the dollars

Some consumer advocates blame loan officers and mortgage brokers who steer borrowers away from prime loans because they can make much more money from the subprime market.

"Dollar for dollar, it is much more lucrative for a broker to sell subprime loans," said Allen Fishbein, a director of credit and housing policy for the Consumer Federation of America.

"I have a friend who interviewed for a job with my company," said Hardester. "He told me, 'I'm not coming to work for you. I can't make enough money.'"

The friend, who had been working in the subprime industry, told Hardester he was used to getting an average of five points-plus for each loan he originated; that's more than $10,000 on a $200,000 mortgage. Hardester's company writes mostly prime loans, where the margins are much thinner - around 1 percent or less.

The color of money

Consumer advocates and community activists say minorities have been especially targeted for subprime loans.

The Consumer Federation of America calculated that African-American borrowers were more than twice as likely as white families to have gotten subprime loans in 2005 - even after accounting for credit score differences and other risk factors. Latinos were also much more likely to receive subprime loans.

Janice Bowdler, housing policy analyst for Latino advocacy group the National Council of La Raza, said, "Even high-income Latino families get more subprime loans than do low-income white families."

One reason, she said: Minority communities are underserved by institutions that deal mainly in prime loans, which effectively funnels residents into the offices of subprime lenders.

The real estate sections of local newspapers add to the problem, according to Bowdler. She pointed to The Washington Post, with a mostly white readership, which features ads for prime loan originators. The ads often have a clear box of the latest rates from various lenders, and the text is laid out to help borrowers comparison shop and save money.

But the ads in the real estate section of Washington D.C.-area paper El Tiempo Latino are quite different. They're primarily from mortgage brokers and they stress - not price - but how borrowers can get loans despite little credit history or documentation.

"Already, you're put into channels that lead to subprime loans," Bowdler said.

Not the whole story?

Duncan, however, doubted that very many prime customers do get put into subprime products.

"I have yet to see any scientific evidence that that is true," he said. "If you only see credit scores, that doesn't capture the whole story."

Jim Nabors, past president of the National Association of Mortgage Brokers, said, "[Fannie Mae and Freddie Mac] may not be seeing the whole picture. They didn't take into account a lot of things that help determine the kind of loan a borrower receives."

These factors include items such as "seasoning" of loans, which takes into account how long a buyer had a down payment on a house and the source of that money, the borrower's debt ration and the appraisal value of the property.

Nabors said that, undoubtedly, some borrowers qualified for prime did get subprimes, but the extent has probably been exaggerated.

The best advice, according to Hardester, is to treat the process of getting a mortgage with the respect a major financial decision like this deserves. In other words, you better shop around.  Top of page