The so-called days of the mortgage boom are over causing a certain amount if disbelief among industry professionals.  Like a bad hangover from Saturday night wild party, those who gained from historic low interest rates and flexible lending products that spawned the real estate boom at the turn of the millennium, are now slowly waking to reality.  The once profitable sub-prime market is now close to extinction as many institutions known as great powerhouses are no longer in the business to originate loans.  While Wall Street may have had a say in rating these companies poorly, the ones who catered to a specific clientele should have seen a shift coming especially when the funding is no longer available.

So what is the big deal anyway?  All this hoopla has many asking, what is a subprime loan anyway?  How does this influence the mortgage industry? So okay, a subprime mortgage is a real estate loan given to a consumer with less than perfect credit and little or no down payment available.  One must keep in mind the majority of loans in a financial institution's portfolio does not consist of these types of loans but during the mortgage boom, many consumers took out these types of loans as a means of affording the American Dream of homeownership.  These loans broke down the barriers to home ownership because of their flexible lending parameters.  What this has now lead to be a marketplace upside down in loans not considered "A" paper but B, C, D and F translating into a high-risk venture?  As home values have risen so has the risky nature of these loans still being unpaid or falling behind.

So how did the bubble burst so badly, one is also wondering?  As subprime became a more popular loan product, so did the practice of selling it to the consumer become more flexible.  More and more lenders approved borrowers with not only less than perfect credit (small blemishes) but also those with poor track records including larger debit issues like previous foreclosure and automobile repossessions.  What further compounded the issue is the lenders sales device of enticing the poor credit customer by offering homeownership programs with minimum documentation needed known as "stated-income" or "no doc" loans.

Wall Street did not make the situation any better and even encouraged the practice by grouping the loans into securities that were sold to pension funds and other institutional investors who were seeking higher rates of return. Later this would not payoff as loans started to default payment schedules. This practice caused concern for seasoned veterans of the industry as many started to label subprime loans as easy moneymakers.  Many warned against this behavior because it encouraged borrowers buy homes more than they could afford. 

This practice only worked as long as home values rose because then borrowers gained equity and could continue to refinance out of adjustable rate mortgage or ARMs.  Still as the market began to change because of this continued behavior and interest rates increased and home values decreased, many borrowers could not continue this refi behavior and were unable to make their payments especially once their new ARM adjusted again.  As a result many consumers once challenged by barriers to homeownership were now facing foreclosure.  With defaults and late payments on the rise, lenders got wise and changed the underwriting standards for the subprime market, even completely removing some loans from their product lines.

For instance, the Piggyback, 2^nd Lien where the home is sold for $100,000 and the buyer's only pay a down payment of $ 5,000 where this makes the balance on the loan $95,000.  This translates to the 1^st Lien being at 80% LTV or $80,000 with the 2^nd Lien Loan being $15,000.

For a homebuyer with questionable credit, for them to only contribute 5% as a down payment was unheard of in the old days of the traditional down payment being 20% of the purchase price.  In this scenario of only 5%, the buyer borrows 80% on the first loan putting the 20% on a second loan as a piggyback to the first loan. This creates more than one lien against the property but also allows the borrower more buying power and to be at the 80% LTV.  This allows the borrower to avoid PMI, private mortgage insurance for the bank's investment or further fees added to the monthly payment. This allows the buyer to borrow a total of $95,000 along with the $5000 down payment and the ability to cash out the seller for the $100,000 purchase price. 

Another selling point of this loan scenario is the 1^st lien mortgage interest rate is usually lower than the 2^nd lien mortgage with the 2^nd mortgage sometimes being in the form of a Home Equity Line of Credit or HELOC loan.  The HELOC is sometimes presented as a credit card and the interest rates act like a credit card depending on the terms and conditions.

The main reason why such lending behavior continued for so long was the win-win it presented to Wall Street and investors.  Sellers especially liked this loan product because they could get all cash from the transaction.

Many would argue that such lending practice should have been seen as predatory sooner than later.  The Piggyback product is truly a danger because it encourages a buyer with little or no money of his or her own to get into house where the sense of equity is unrealistic.  There is no true equity. Also if the borrower found themselves in trouble, there is little they can do to bail themselves out.

The credit rating is also a cause for concern because of the risky 2^nd lien mortgage and its credit line.  This loan also takes a back seat to the 1^st lien mortgage, meaning upon foreclosure it almost never paid.  It is bad news to those on Wall Street.

This can leave buyers and their real estate agents in a pickle because they are left trying to negotiate with the seller to carry the 2^nd lien for the buyer.  This sort of creates a seller financed second mortgage but this almost never happen because more sellers want the transaction finished, not to mention the risk they are taking on their own financial well-being.  This should only be accomplished under severe circumstances or in cases of helping family with a tight legal contract.

Still as the market continues to rebound from recent subprime trouble, one may see seller financing on the up surge and useful.  This can only be done if the risky piggyback 2^nd lien mortgage is not a part of the equation.  Why not consider it then if the seller if about to get asking price in this current market and actually sell a home instead of waiting.

Really is this enters into the arena of creative and alternative financing and leaves the traditional notion financing in the dust.  The following scenario shows how owner financing is most certainly achievable.

Here the home is sold for $100,000 and the buyer's only pay a down payment of $5,000 where this makes the balance on the loan $95,000.  This translates to the 1^st Lien being at 95% LTV or $95,000 seller financed.

How this is different from the previous example is that the seller consents to finance the buyer under the terms of the sale whereby agreeing to hold a home loan in the amount of $95,000. 

So how does this benefit the seller? Sounds unfair especially if the seller is holding the majority of the mortgage for the buyer?  How does the seller win in this example? What ends up happening is contingent on the pre-sale conversion of the $95,000 seller financing as lump sum.  

This allows for the following assumptions:

• The seller has completed a background check into the buyer's employment, stability and character, also past track record with landlords and other credit ratings.
• The contractual repayment schedule of the seller financing is dependent upon these variables adding up.

At this point, it would be smart to use the services of an accountant or if doing it your self is the only means, definitely utilizing a cashflow application is warranted.  So what happens is that the $95,000 seller financed mortgage usually sells quickly within the $85,000 to $87,000 range for a lump sum.

How this risk for the seller pays off is that they usually get $87,000 from the sale of the seller financed mortgage plus the $5,000 down for a total amount of $92,000 which really benefits everyone in the long-run because the even higher risk piggy back is avoided altogether.  This type of scenario is desirable for real estate investors with numerous properties in their personal portfolio because it promises that they will indeed sell the property and in today's market that is guarantee enough.