- The Washington Times - Friday, June 8, 2007

I was sitting on my back porch with my wife enjoying the weather when we started talking about this column. She suggested that I write a column explaining common mortgage terms and what they mean for the consumer. She says a lot of folks don’t have a clear understanding of many words used in the mortgage business.

The terms in this column will focus on the subprime segment of the mortgage market.

m Subprime: Folks who cannot qualify for conventional competitive mortgage programs often turn to subprime mortgage products. These products carry higher interest rates and fees in order to compensate for the riskier applicants.

What it means: In recent months, the subprime mortgage market has experienced a considerable meltdown. Subprime mortgage companies aggressively market their products to a lot of folks who are not ready for the serious commitment of homeownership. Just because a lender is willing to make a loan doesn’t necessarily mean taking the loan is in the consumer’s best interest.

My opinion is that most folks who take a high-rate, high-fee subprime loan are not financially ready for the commitment.

m Prepayment penalty: A mortgage loan that charges a fee in the event of an early payoff carries a prepayment penalty. The penalty can be as high as 3 percent of the balance of the loan and typically is charged if the loan is paid off within the first three years.

What it means: A hefty prepayment penalty prevents borrowers from refinancing their mortgage into a more favorable program. Most subprime programs carry these penalties, making it impractical for folks to obtain a better mortgage even if their credit rating improves. Avoid loans with long and stiff prepayment penalties.

m Credit scores: A comprehensive statistical model rates a borrower’s credit risk. The lower the score, the riskier the applicant. In order to qualify for the best mortgage programs, a credit score should not be lower than 700. Recent late payments on installment and revolving loans will sharply bring down a credit score. If the applicant is “maxed out” on his credit cards, he also can expect lower scores.

What it means: A low credit score can be catastrophic to a consumer’s long-term financial health. If you have bad credit, you will not be eligible for affordable loans. Because subprime loans are so much more expensive, it often overwhelms the borrower and exacerbates a difficult situation.

m Alt-A: Short for alternative A, these programs fall between traditional competitive mortgage programs and the subprime market. Alt-A programs have looser underwriting guidelines than the A credit programs but are not as loose as many subprime programs. Predictably, these programs carry rates and fees that are higher than A credit paper but lower than subprime programs.

What it means: Alt-A programs are a good alternative for folks who, for one reason or another, are not eligible for traditional financing. Most of these programs carry a modestly higher rate and no prepayment penalty. These programs are far superior to the subprime products.

m No Doc: Short for no documentation, a No-Doc loan allows the borrower to obtain the loan without any documentation on income or assets.

What it means: A No-Doc loan is good for folks who can intrinsically afford the mortgage requested, have good credit and a good down payment but may not be able document acceptable income on paper.

In a future column, we’ll discuss terms that surround adjustable-rate mortgages, or ARMs.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@ pmcmortgage.com).