Subprime loan alternatives

Where credit-challenged borrowers can go for a mortgage loan - without the painful interest rates

By Les Christie, staff writer

NEW YORK ( -- After the subprime mortgage market collapsed, many products that were widely available have disappeared from the scene.

More than a score of subprime lending specialists have closed their doors. And many banks like Washington Mutual (Charts, Fortune 500) and Wells Fargo (Charts, Fortune 500) have cut back on or eliminated subprimes, leaving many credit-damaged home buyers scrambling to find a loan.

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But now that the collapse has shaken out some of the sketchier players, some familiar and more reliable alternatives to subprime are making a comeback -- but they do require some work.

Federal Housing Administration

According to Jerry Brown, a public affairs officer with the FHA, the administration wants to make it easier for low and middle income, credit damaged and first-time home buyers to get a foot in the door.

FHA loans originated during the Great Depression when foreclosure waves put hundreds of thousands of people onto the streets. They're offered by private lenders but insured by the government, reducing risk, so lenders are willing to make them at favorable terms.

FHA loans used to be more popular, but they were eclipsed by easier-to-obtain subprime products. Their market share fell from 18 percent of all home loans in 1990 to less than 4 percent by 2006, according to the National Association of Home Builders.

One reason is that the application process for an FHA loan is more tedious and requires more paperwork than that of subprime loans touted during the housing boom.

Today, there's a new push toward FHA. Assistant Secretary for Housing, Brian Montgomery, testified before a congressional committee in favor of modernizing the process for the benefit of "troubled subprime borrowers."

Requested changes include: Eliminating a 3 percent down requirement, which would enable more low income borrowers to qualify; increasing the maximum loan to reflect the increase in home prices brought by the housing boom; assigning rates by risk to enable borrowers with higher credit scores to receive lower interest rates.

The first step a prospective home buyer hoping for an FHA loan should take is to contact several lenders. It's important to comparison shop because the lenders offer different terms and rates, just as in conventional loans.

FHA loans with low interest rates can be approved with low down payments. Adjustable rate mortgages (ARMs), which can help buyers to get through the first, and often most difficult, year of ownership, are also available.

The FHA ARMs reset yearly at no more than 1 percent higher than the original rate, and can rise no more than 5 percent above the original rate, keeping them affordable for borrowers.

Another advantage to FHA loans, according to Brown, is the credit counseling that comes with, which the agency recommends. They also requires lenders to help borrowers in trouble instead of simply foreclosing on their homes.

FHA's mortgage programs typically have no maximum income limits for qualifying; many high-income borrowers have FHA loans. But, as Brown pointed out, FHA loans target low and moderate income borrowers and offer little advantage over prime rate loans. Few high-credit-score borrowers choose to go through the more complicated process of obtaining them.

Veteran's benefit

Another government guaranteed loan with attractive terms is a Veteran's Affairs loan. The borrower has to be a veteran or the surviving spouse of one who died from a service-connected condition. Loans are available for up to 100 percent of the purchase price.

Many veterans who don't qualify for a subprime loan may still be able to get a VA loan, according to Nathan Long, Chief Executive of Mortgage Research Center, a VA approved lender. VA loans are often made to borrowers with a couple of dings in their credit histories.

"Even severely credit damaged borrowers can qualify for a VA loan after only 12 months of clean credit history," said Long.

Rates are extremely competitive. A 30-year fixed carries about the same rate as a normal prime rate loan, currently about 6.75 percent, according to Long.

It's an even better deal than that, because 100 percent of either the purchase price or the appraised value of the property (whichever is lowest) can be financed without separate mortgage insurance, which adds a point or two to the rate of a prime loan for the final 20 percent of the principal.

Community development

A little-know loan product is the "census tract" or Community Reinvestment Act (CRA) loan. According to Steven Habetz, a mortgage broker with Threshold Finance in Connecticut, the CRA requires banks starting business in a new area to help meet the credit needs of the entire community. That translates into loans to low and moderate income borrowers.

And with the current boom in retail banking expansion, there's a lot of liquidity looking for low income borrowers.

"Things have gotten very competitive," said Habetz, " and many banks are looking to make these loans. They may subsidize them by a half percentage point or more and a large portion of most urban areas are eligible for them."

The loans can boast low interest. Habetz said, "We can do a 30-year fixed at 5.75 percent right now for a couple of points." (Points are fees paid up-front to lower the interest rate for the entire term of the loan.)

Borrowers with credit scores of 600 can qualify for these loans. And you don't necessarily have to buy in a low-income area to be eligible.

"If your income is 80 percent or less of the median for a county, you can qualify, wherever the house is located," said Habetz.

Even if your income is too high to ordinarily qualify, but the house you're buying is in the low-income census tract, you can get a loan. Habetz pointed out that in many of Connecticut's small cities, such as Bridgeport, the entire town is defined as a low-income tract.

To see if the house you're interested in buying is in one of these areas, go to the Federal Financial Institutions Examination Council and click on "Geocoding/Mapping System." Type in the property's address and hit search.

On the resulting page, hit "Get Census Demographic." The page that appears will have a box identifying the tract income level. If the income level is low or moderate, the property is eligible for the loan. Top of page