Mortgage lenders get creative

NEW YORK (CNNMoney.com) -- Following the subprime mortgage market collapse, new loans are down, and lenders are turning back to safer - less profitable - offerings. But with tougher competition and a shrinking market, they're getting a little more creative.

In January, more than 60 percent of all mortgage loans were made to prime customers with FICO scores of 650 or more. Those customers most often go the traditional 30-year, fixed-rate route - a simple, unsexy product that offers lenders little room to differentiate or to squeeze more profits out of their loans.

That means there's a smaller pie of less profitable loans to be divvied up, prompting lenders to come up with new ways to market their offerings.

"Everyone is trying to be a little creative," said Bob Moulton, founder of Americana Mortgage Group.

Retail banker Washington Mutual, (Charts, Fortune 500) has weighed in with a flexible mortgage that allows borrowers to switch from a fixed rate to an ARM and back again - without refinancing - at little or no charge.

Bank of America, (Charts, Fortune 500) has been publicizing a no-fee mortgage that requires no application fees, lender fees, appraisal fees, origination fees or private mortgage insurance (PMI), even if the loan-to-value ratio is greater than 80 percent, the normal PMI cutoff point.

According to Liam McGee, the bank's president of Global Consumer and Small Business Banking, the mortgage was developed as a response to customer demand for a mortgage "truly free from confusing fees."

Credit unions are also getting into the act, offering a new version of what the Credit Union National Association (CUNA) has dubbed the "home loan payment relief," or HLPR, loan. It works somewhat like a hybrid ARM, or the so-called exploding ARM that has caused so much turmoil in the subprime lending world.

Usually, hybrid ARMs loans carry low, "teaser" rates for the first two or three years and then reset at higher, sometimes unaffordably higher, rates. They are being blamed for causing a spike in foreclosures this year.

Like exploding ARMs, HLPR loans come with interest rates one percentage point below the national average at the time of the loan for the first three years. That's where the similarities end.

When the HLPR resets, it only goes up to the national rate average at the time of the initial loan. There are no surprises; borrowers know just how affordable their mortgage will be three years down the line when they first sign the papers.

Bill Hampel, chief economist with CUNA, called the loan a marketing tool to get Americans better acquainted with borrowing through a credit union. He said the organization "would like to remind people that credit unions are a good deal."

The loan is open only to middle- and lower-income home buyers; household income must be no higher than the median for the area, except in very high priced housing regions such as California - where median income can be 133 percent of the area - and Long Island, where it can be 165 percent.

Ditech, an online lending arm of GMAC, has come up with its own version of the 30-year fixed, bundling the mortgage with a home equity line of credit (HELOC) and a credit card rewards program.

Borrowers automatically have access to any equity their home has accumulated via the HELOC. There's no application process or fee.

And credit card charges earn points that can be used to reduce the mortgage principal. Putting $2,500 in purchases on your card will reduce your mortgage by $25.

Ditech is one of the lenders that have cut back on their subprime loans to practically zero. According to general manager Rick Powers, only about 1 percent of the loans the company extends qualify as subprime.

And although the new product is designed to attract customers into more profitable loans, they won't be much more expensive than the cheapest deals out there.

"Our play is not to be the best rate but if you don't have competitive rates you're not going to get the business," said Powers.

Correction [updated]: An earlier version of this story incorrectly reported that mortgage originations were down 80 percent this year. In fact, they are 80 percent of what they had been - or down 20 percent.

The story also contained several facts about exotic mortgages that were deleted for readability and clarity. While the numbers were accurate, the time-frame of the comparisons were not: We said they compared January 2007 with January 2006. In fact, the comparisons were with an average for all of 2006.