Creative real estate lending helps CUs balance risk and serve members with less-than-stellar credit histories
Move over Money Store and other high-priced finance companies-and take your overthe-hill, ex-jock spokesmodels with you. Credit unions are expanding their nonconforming real estate loan offerings to do battle with high-loan-to-value (HLTV) and subprime lenders. And they're finding creative ways to serve members burdened by substantial credit card debt and blemished credit records.
HLTV real estate loans typically are home equity loans and mortgages exceeding the 80% loan-tovalue threshold for conforming to secondary market standards. HLTV lenders that gain the most attention are those lending 125% of the property's value. Some lenders, such as American Family Loans Corp. in Huntington Beach, Calif., will lend up to 150% of the property's value.
Subprime lenders target consumers with such poor credit records they're unable to obtain credit elsewhere. They charge interest rates and points far above market rates to compensate for the risk.
Credit unions are small players in the multibillion dollar HLTV and subprime mortgage marketsand in the overall mortgage market. Only 44% of credit unions offer first mortgages and 30% offer home equity loans. Credit unions accounted for only about 7% of the $1.4 trillion in mortgages originated in 1998, says Tom Decker, vice president and executive director of CUNA Mutual Group's Lending Lab.
In some cases, competing with HLTV and subprime lenders means linking with competitors to provide loans better left out of credit unions' portfolios. In other instances, credit unions treat some real estate loans as if they were unsecured. And risk-based pricing allows many credit unions to serve members previously sent elsewhere. Baxter Credit Union in Deerfield, Ill., has been making 125% loan-to-value mortgages to members for more than a year in partnership with CU Plus-a joint venture between Bear Stearns & Co., Inc., New York City, and Dallasbased First Plus Financial Corp. The credit union markets and originates the loans and sells them to CU Plus, which farms them out to investors, explains Bob McKay, Baxter Credit Union's chief operating officer. This way, the credit union doesn't assume any risk.
The loans, targeted at consumers with substantial credit card debt, typically are closed end and amortized over 10 or 15 years. The price is higher than for most credit union loans-13% to 14% interest plus several points. Baxter Credit Union earns 2% of the origination amount.
"This product definitely fills a need," McKay says. "Maybe people shouldn't have $30,000 in credit card debt, but they do," he says. "You have to ask, what's the best way to manage their money? This loan helps them do that from a monthly cash flow basis."
McKay says studies from First Plus indicate consumers don't typically reload on credit card debt after paying it off with HLTV real estate loans. "First Plus looks for people who have a lot of debt, but have demonstrated an ability to handle that debt," he says. "Its underwriting is more strict than the credit union's. The average Fair Isaac credit report score on these loans is 680, which is 'A' paper."
However, the global financial crisis silenced the once-booming market, causing a flight to quality among investors and away from the riskier HLTV and subprime markets. "The wheels have fallen off the market during the past few months," McKay says. "First Plus has had a rough go of it lately. They've lost a lot of their liquidity and haven't been able to fund loans. They're taking the deals we do but we're not pushing it. There's demand but we're not marketing the product now."
Some major firms have gotten out of the HLTV business, including The Money Store and DiTech Funding-the nation's 12th and second largest HLTV lenders, according to Origination News. Although The Money Store's net income on HLTV loans nearly tripled from 1994 to 1997, so did its 90day delinquency ratio, rising from 1.86% at year-end 1994 to 4.38% at year-end 1997, reports Credit Risk Management Report.
A no-equity solution
This exodus hasn't scared off Wescom Credit Union in Pasadena, Calif., from offering HLTV equity first-trust deed products. "We have a no-equity program. We don't require equity," says Bill Steele, Wescom Credit Union's vice president of real estate lending. "We could be at 110% or 160%. We don't even look at value because it's really like making a credit decision as we would on a consumer loan. We underwrite it like a consumer loan, but it's a real estate loan all the way through."
The maximum no-equity loan amount is $25,000, all of which is counted against a $30,000 maximum members can have in unsecured loans. Delinquencies have been almost nonexistent, although the credit union has offered the loans for only two years, which is when delinquencies tend to start surfacing on real estate loans, Steele says.
"You have to monitor members a little closer," he says. "And if payments are late, we start calling them a lot sooner than we would for a first trustee holder."
Wescom Credit Union makes $500,000 in no-equity loans during a typical month without advertising them. "It's not a loan we push," Steele explains. "It's an alternative we offer members who come in for 80% loan-to-value loans but have no equity in their homes. It's been a nice program for our members. If we didn't do these loans, members would go elsewhere. If we're going to meet our members' needs, we must provide an HLTV product."
Plus, on traditional home equity loans, a member could have a $10,000 or $20,000 line of credit and never make a draw on it. With the no-equity product, members typically draw what they need right away so the loans earn money from the start. "This part of our portfolio is performing better than anything else," Steele says.
Dangers lurk with HLTV lending
Not everyone is enamored with HLTV loans, including CUNA Mutual's Decker.
"If we had HLTV mortgages or second mortgages at the credit union I used to work for, the losses would have been devastating when our sponsor went through a major downsizing," he says. "Few credit unions could afford losses if there was a downturn in the economy and all the appraised home values went south. We've seen it happen. You go in with an 80% loan and all of a sudden you have 125%. I don't want to see credit unions going into 125% loans and finding themselves with 200%. It can happen overnight."
Plus, Decker says the first thing most consumers do after paying off credit card debt with home equity loans is to reload their credit cards. "After they take out the second mortgage and reload their credit cards, they run out of options. Everyone talks about how prosperous the economy is, but what's going to happen when the inevitable downturn hits?"
He maintains a better way to free members from credit card debt is to counsel members about using credit wisely. "We need to do it now because we know bad times are coming," Decker warns. "When members come in to borrow money, we need to sit down with them and talk about their personal finances before it's too late. You need to get your members in the door to talk about the ramifications of 125% loan-to-value loans. It's a shame that schools haven't taught people how to handle money. The need is there. Look at the number of bankruptcies."
Rising bankruptcies aside, Steele and McKay say their members haven't reloaded on credit card debt after paying it off with HLTV home equity loans and mortgages.
"It hasn't created a problem for us, at least in our collection area," Steele says. "I'd think we'd start to see symptoms if we were having collection problems. It's a high probability, but it's going to happen anyway. The opportunity for us is that at least it's a secured transaction. And you're making the same credit decision as any other loan. We look at other factors in addition to credit score-members' outstanding unsecured credit vs. monthly income, how many people in the household earn income, time on the job, and other factors that contribute to future stability.
"The competition is just too much when you offer only standard products," Steele continues. "That's why we went with the no-equity loan. Members said they wanted 125% loans and we weren't offering them. We knew they were going out and getting them elsewhereand many of these were members we had first-trust deeds with."
McKay says Baxter Credit Union, which kept about $1 million in 100% loan-to-value mortgages and home equity loans in portfolio last year, looks at how members have managed credit in the past and how they'll manage credit, based on their incomes, in the future. The credit union treats 100% loan-tovalue mortgages and home equity loans like unsecured credit.