Subprime loans
As a first-time home buyer or someone with a tough credit score you may be looking for some “creative financing” options. Beware subprime loans. These are offered at a rate above prime to individuals who do not qualify for prime loans. Subprime loans tend to be 0.1% - 0.6% higher than prime. Doesn’t seem like much? Actually it translates to thousands of dollars of interest payments in most cases.

Unlike the conventional mortgage market, the market for subprime home loans is confusing, daunting and full of potential pitfalls. Mortgages for people with damaged credit vary widely from lender to lender, with rates, terms and pricing all over the map. That means borrowers better learn how to shop before they start.

The conforming loan is basically a commodity. The rules are pretty standard, all the lenders are competing and the paper ends up getting sold to Fannie Mae or Freddie Mac. With a subprime loan, every loan is different and every borrower's story is unique. Each originator will assess the risk differently and they will each have different guidelines.

Understand how things work
To understand why, consumers need to understand how things work in a mortgage lender's back office. Most sell their conventional loans to Fannie Mae and Freddie Mac. The two agencies either hold the loans in their portfolios, making money off the payments people send in, or bundle them together into mortgage-backed securities, which are then sold to Wall Street investment companies. Because the agencies dominate that part of the business, most lenders and brokers receive roughly the same price for their loans. That means rates charged to consumers vary little from one lender to the next. Fannie Mae and Freddie Mac set underwriting standards that loans have to meet before they'll buy them, too. So, lenders follow pretty much the same guidelines when deciding whether to make a loan. On the subprime side, mortgages and home equity loans can end up in any number of places. Large finance companies buy some of them. Investment firms buy others for packaging into a different variety of mortgage-backed securities. Some are even held in portfolio and serviced by the lenders making them. That means subprime originators have much more leeway when it comes to setting rates and underwriting standards. As a result, rates, fees and program guidelines vary drastically depending on which broker or lender a consumer visits.

Devote extra time to shopping for mortgage
Because that's the case, subprime borrowers need to spend much more time shopping lenders and brokers than their conventional counterparts. Each company will likely offer different rates and fees for the same types of loans, depending on which investors they turn to for financing. Damaged-credit consumers should hone their negotiation skills, too. Subprime lenders have much more leeway to adjust their rates because their margins, or differences between what the money costs them and what they lend it out at, are wider than those typically found at conventional lenders, experts say. Mortgage lenders do have investors whom they have to keep happy and they have to package the product in ways that investors will buy it, but there can be ways to negotiate within that.

How to save some money
There are other less obvious ways savvy subprime borrowers can save money, too. Consider that subprime lenders grade customers the same way that elementary school teachers grade children. Depending on an applicant's credit score, debt-to-income ratio, ability to verify income and other variables, a lender or broker assesses a letter grade that typically ranges from "A+" down to "D." The loan officer then charges a rate appropriate to that category. Because the distinctions between categories are often slight, borrowers can move up the scale without much effort.

For example, lenders tend to grade people based on how many times they were 30 or 60 days late with their mortgage payments in the past year. Having two "30-day lates" might push them into the "A-" category while having just one would keep them in the "A" zone. As a result, a customer who was late twice, but one of the late payments was 11 months ago, can improve a notch by just waiting a few extra days to borrow. By doing so, that customer could save a half a percentage point, or 50 basis points, on the interest rate, according to pricing sheets wholesale lenders send to mortgage brokers. Scrounging up a few extra dollars can make a big difference, too. Lenders generally adjust their rates lower for each 5 percent drop in a mortgage's loan-to-value ratio -- the difference between the loan amount and the value of the property securing it. Someone with a $100,000 home who wanted to pay off debt by refinancing could save 50 basis points by getting a $79,900 loan rather than an $80,100 one. Of course, knowing how to avoid rate hikes is just as important as knowing how to earn rate breaks. That's why borrowers might find it interesting to learn that lenders provide brokers with a list of things that will boost a borrower's rate. Some are things people have no control over. After all, if you're buying a condominium, you're buying a condominium and you'll probably have to pay half a percentage point more to do it.

What you CAN change
But other variables can be manipulated or taken out of the picture altogether. Think twice about withholding documents to prove income and assets, for example. You'll get a "no doc" rate, which can be as much as a full percentage point higher than a regular one. Also, try to pay off some bills before applying, because a debt-to-income ratio of more than 50 percent can add 50 basis points to the loan rate. Be sure to scrutinize any prepayment penalty as well, because most subprime loans come with them. You might be able to lower your rate by accepting a longer-duration penalty, such as one that lasts for five years, but you may not want to do so. That's because you'll probably be able to refinance into a conventional loan before the penalty expires because it only takes one or two years to rebuild credit these days.

Online Mortgage Deals May Have Shaky Foundations
Ann Starnes of El Paso, Texas, wasn't in the market for a mortgage. But in late May, she found a tempting offer from a company called Lendbridge in her e-mail queue, and she started giving it some serious thought.

"Ever since we unveiled our new lending program, every property owner in town is jumping on board," read the message. "Bad payment history is OK. With our new plan, we view you as more than just a FICO score"– a reference to the rating many financial institutions use in deciding whether to make loans to consumers.

The mortgage rates that Lendbridge advertised were spectacular – as low as 3.46 percent. All Starnes had to do to apply was visit a Web site and type in answers to a few questions about her home and her desired loan. Then, Lendbridge promised, within 48 hours, "We'll search our network to match you with the best lender in your area based on your credit situation and financial needs."

But before filling out the form, Starnes wisely tried to confirm some basic company information on the Lendbridge site, and it didn’t check out. According to MapQuest.com, Lendbridge's Austin address didn't exist. And its 800 number yielded a generic answering machine message. "I would be suspicious about any site that wants your information, and yet is giving you incorrect information," she says.

A Consumer Reports WebWatch review of Lendbridge found more reasons to be wary. The Web address in the e-mail Starnes received was not www.lendbridge.com – a dead url that doesn't lead to any site – but a more complicated link (www.crinumlily.us/lendbridgemedium_rt). That address and www.lendbridge.com are both registered to "Steve Goudreault" of "American Loan Rate" in Reno, Nev. Phone messages left at a number listed with the Internet registration were not returned.

Tell Us About Yourself…
Online banking experts say unsolicited e-mail offers like the one Starnes received are exploiting the popularity of major online mortgage sites such as LendingTree and E-Loan, which offer would-be borrowers the chance to comparison-shop for low rates among many lending institutions.

"These are a lot like traditional 'phishing' scams that use similar names to trick the recipient into giving up personal information, for fraudulent purposes," says Mary Beth Guard, executive editor of BankersOnline.com, a discussion site that offers consumers advice from bankers. "They are often selling your information to lenders, and it could end up anywhere."

That's exactly what happened in December, when the U.S. Federal Trade Commission (FTC) halted a scam run by 30 Minute Mortgage Inc., an Internet operation that e-mailed spam offers for "3.95% 30 Year Mortgages"– despite the fact that 30 Minute Mortgage was not a lending institution at all. But the FTC says the outfit did manage to get thousands of consumers to fill out applications listing their Social Security numbers, income and assets, then secretly sold the information to third parties.

"We're very concerned about consumers providing their personal information online and then discovering that it's being used for a different purpose," says Amanda Quester of the FTC’s Bureau of Consumer Protection, which has stepped up investigations of mortgage fraud online. (This month alone, the FTC charged PWR Processing, a group of Colorado mortgage brokers, and Chase Financial Funding, a California broker, with advertising illegal or nonexistent mortgage deals via the Internet.)

But even if ill-gotten information ends up in the hands of legitimate brokers, there can still be serious consequences for the consumer. In the worst cases, say critics, eager loan officers run credit inquiries before they contact consumers – a burst of activity that usually looks suspicious to credit bureaus and may cause them to lower credit scores.

William Tygart, an Allyn, Wash., mortgage broker, says he encountered just such a nightmare scenario last fall, when a borrower forfeited a high FICO score of 710 after venturing online: "After he filled out the applications, he was contacted by numerous mortgage brokers that had offers for him. The offers stopped coming, and the borrower found out that he had dropped to a 520 credit score because of 103 inquiries within two months. Now this gentleman cannot get the rate that he deserves."

Fear of multiple credit checks has also dogged established online loan sites like E-Loan and LendingTree, whose large roster of lenders is no less credit-history conscious. But both companies allow consumers to defer credit checks until they decide to move ahead with a particular lender, allowing them to limit the overall number of checks.

"The best thing consumers can do is keep track of how many people you are working with," says Mindy Neubauer, a LendingTree spokeswoman.

Finding an Online Lender
Because the Internet offers the advantage of comparison-shopping to find the lowest mortgage, some advocates recommend tempering the risks with a dose of offline detective work.

“The two mortgages I've gotten, I applied for and was approved for online,” says Guard.“But you have to exercise caution and be very sure of what you're getting into.”

To do that, Guard recommends following these steps:

• Before shopping for mortgages online, find out what the prevailing mortgage rates are in your area by checking local newspapers and established industry sites such as BankRate.com.“There is a lot of variation around the country, and banks may have raised or lowered rates in your area,” Guard says.
• When shopping for mortgages online, ask friends what lending institutions they used to buy real estate and whether the firms operate online.
• Search engines can be helpful in discovering whether a particular online lender has a negative track record. In addition to typing the lender's name into major search engines, check the FTC's Web site (www.ftc.gov) to make sure there have been no federal proceedings or disciplinary actions against it. If the institution is federally insured, check the FDIC's Web site (www.fdic.gov). If it's a credit union, check the National Credit Union Administration site (www.NCUA.gov).

Sidebar: Useful Tips and Resources
The FTC encourages consumers to make sure their transactions -- online and off -- are secure and that their personal information is protected. Tips to help consumers manage their personal information wisely and to help minimize its misuse are provided at http://www.ftc.gov/…privtipsalrt.htm.

The FTC recommends consumers:

• Never respond to a solicitation directly unless you have an established relationship;
• Never click on a link from an unsolicited email offer. If the offer is from a known company, always go through an established "front door" (e.g., the company's known Web address or telephone number).

For more information:
http://www.ftc.gov/…cybrsmrt.htm

If you’re shopping for a mortgage, consult this consumer tip sheet, also from the FTC: http://www.ftc.gov/…bestmorg.htm