GM said that it plans to buy sub-prime auto lender AmeriCredit Corp.
Before the mortgage crisis and the recession, GM owned GMAC, which made auto loans that facilitated a lot of GM car sales, but GMAC also funded mortgages. When the financial crisis hit, the mortgage side of GMAC suffered the most.
General Motors is back in the auto loan business, including sub-prime auto financing, helping dealers to sell more GM cars.
Will GM venture back into making sub-prime mortgages as well? probably not, at least not the way they did in the past. Sub-prime auto financing is considerably different from bad credit mortgages.
Treat a Mortgage Like a Car Loan
The bad credit mortgage crisis happened because lenders and investors assumed that house prices would keep going up — or would at least not fall on a nationwide basis. But sub-prime auto financiers know that cars lose value steadily. That means auto lenders have to be more conservative about the value of the assets backing their loans and understand that borrowers behave a certain way in tough economic times. Mortgage lenders made their decisions based on the assumption that borrowers would blow off other debts to keep paying the mortgage and to hang on to their homes at all costs. Auto lenders made no such assumption.
“Historically homeowners had positive equity in their houses. So they would pay the mortgage first and default on other loans like auto loans,” said Sean Egan, president of Egan-Jones Ratings. When house prices dropped, the reverse became true. Having defaulted on their mortgages, borrowers were better able to make their car payments.
“There have been lots of home loan defaults before people defaulted on their auto loans,” Egan said.
So why shouldn’t sub-prime mortgage lenders act more like sub-prime auto lenders?
That would mean making money available to those under certain conditions. Probably more like the way mortgages were made before Fannie and Freddie made 30-year fixed mortgages the norm.
Make a big down payment mandatory. If you were lending on a car that would lose value the instant it was driven off the lot, you’d want to have that covered. A 20% to 25% down payment should do the trick.
Let the payment schedule keep up with possible depreciation. The problem with today’s mortgage is that very very little of the payment initially goes toward repayment of the principal, so it’s tough to build equity without some property appreciation. Sub-prime mortgages should come with 15-year terms to combat that problem.
By making sub-prime less risky, you could bring down the costs. One big problem with bad credit mortgages in the past was that lenders focused on the interest rate (very high), without worrying about how the borrower was going to afford it. They approved loans with itty bitty down payments, very high debt-to-income ratios, and few ir no reserves. Then they sold the loans off to investors who loved the very high rates and again did not consider that most borrowers would be unable to sustain that kind of payment.
But if you made bad credit mortgages with big down payment requirements, asset requirements, and full income verification (not necessarily in accordance with Fannie Mae or FHA guidelines), the risk is lower and the interest rate need not be spectacularly higher than prime rates.
Such reform would make subprime financing available to those who can afford it, and a decent and safe investment for those who provide it.
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