The implications of a rise in subprime lending.

Author:Cutts, Amy Crews


Seven years after the Great Recession, credit trends are settling into a new normal. One noticeable trend is an uptick in subprime lending--but it's nothing like the old subprime.

Lending to borrowers with subprime credit scores (defined as consumers with an Equifax Risk Scoresm of 620 or below) is on the rise. According to data from Equifax, $57.7 billion in new first-lien mortgages was originated to this segment in 2015, while the total number of new loans originated for subprime borrowers also increased 22.5 percent, from 293,000 in 2014 to 358,900. [paragraph] Similarly, the total balance of home-equity lines of credit (HELOC) originations for borrowers with subprime credit scores was more than $743 million--an increase of 8.2 percent from the previous year. [paragraph] In 2016, this pattern continues. The data shows that $5.4 billion in subprime first-lien mortgages was originated in January, an increase of 3.8 percent relative to January 2015, while the total number of subprime first mortgages increased 52.3 percent (from 20,000 to 30,500). In that same time, subprime originations of HELOCs totaled $53.7 million, an increase of 10.1 percent. [paragraph] These patterns might lead some to believe that the growth is the result of relaxed credit standards, but there is more to these increases than meets the eye. [paragraph] From a deeper dive into the data, we see something else occurring with credit standards, as well as some interesting points regarding a shift in the size of the home-equity lending market and a new role for HELOCs. [paragraph] So what is really going on with the increasing subprime mortgage market and how will it shape the industry?

Looking back

To appreciate the potential impact of this trend, we need to first provide some historical context and review the changes that have shaped the environment thus far.

The mortgage industry is analogous to a bicycle, with credit standards acting as the nuts and bolts. Early on, the tightening in standards might be akin to using one's fingers to tighten the bolts, then later a wrench. Finally, the nuts are tightened by placing a foot on the bike and using all of one's strength to tug the wrench one-quarter turn further. The increasing amount of subprime lending today is the equivalent of spraying lubricant on the nuts and bolts of the bike. Make no mistake, this is a very simplified analogy for a very complicated process.

In reality, the increasing levels of subprime lending indicate that credit standards are little changed from a year or two ago, and are more likely stemming from more creditworthy borrowers in this credit range seeking to be homeowners or to refinance their existing loans.

Many standards have changed in the lending industry that make it easier for lenders to separate out higher-risk loans from lower-risk ones. Soon the industry will be using trended credit data, which identifies, among other things, whether borrowers are transactors or revolvers on their credit cards. Transactors generally pay off their balances each month while, in the extreme, revolvers pay only the minimum required amount. Transactors might have lower risk profiles than revolvers, all else being...

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