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Subprime borrowers facing tougher qualifications for mortgages

Thanks to relaxed lending standards, in recent years borrowers with bad credit -- such as a bankruptcy or a delinquent loan on their records -- found it relatively easy to get home mortgages.

Such "subprime" borrowers generally have to make higher interest payments to compensate the lender for the added risk of default they represent. So lots of subprime borrowers kept their house payments lower by taking out exotic mortgages such as adjustable-rate, interest-only, or negative-amortization mortgages.

And would-be home buyers with blemished credit records are finding buying a house has become more difficult and more expensive.

"It's tightening up a lot," said Eddie Carmona, branch manager at Homewood Mortgage in Carrollton, Texas, a mortgage broker that handles subprime borrowers.

Carmona said down payment requirements are the biggest change he's seen.

"Before, you didn't have to bring a down payment," Carmona said.

Other changes:

Higher credit scores. Previously, borrowers with a FICO credit score as low as 570 (out of 850) could qualify for a single loan financing 100 percent of their home purchase, Carmona said.

"Now, across the board, it's jumped up to a 600 FICO score for an 80/20 loan," Carmona said, in which a second loan has to be taken out to finance the remaining 20 percent of the home value.

Rising interest rates. Rates on subprime mortgages have risen about a full percentage point since September, Carmona said, while regular mortgage rates have been relatively steady.

More stringent savings requirements. "They want to see borrowers have at least three months of reserves in their account in case of an emergency," Carmona said.

During the housing boom, borrowers and lenders took comfort in the fact that home prices rose and rose, with no signs of slowing. Even if a borrower had an interest-only loan, the rising value of the home would build equity for the owner.

But with home prices falling in many parts of the country, that safety net has been eliminated. And with interest rates rising, borrowers with adjustable-rate mortgages are facing higher monthly payments and, increasingly, foreclosure.

Mortgage delinquencies in the third quarter rose across all types of loans, says the Mortgage Bankers Association.

"Increases in delinquency rates were noticeably larger for subprime loans, particularly for subprime ARMs," or adjustable-rate mortgages, the group said.

Unfortunately, some lenders who made those risky loans were driven by their own self-interest, Carmona said.

"I believe some loan officers are much more concerned with producing than with the client's best interest," he said. "There is a big difference between the ability to qualify and the ability to afford, and there are borrowers and loan officers who ignore that simple truth."

Loan officers also didn't have to worry too much about carrying questionable loans, because they could quickly package and sell the mortgages as bonds in the financial markets.

Investors who buy those bonds are a major source of funds for mortgage lending. They're also among the forces creating the current backlash against lenders.

"Investors are starting to look at their books with a more jaundiced eye and seeing loans aren't performing the way they want," said Keith Gumbinger, an analyst at HSH Associates in Pompton Plains, N.J., which publishes mortgage information.

Those who remain in the market are demanding a higher return on their investment in subprime mortgages, and a way to do that is raise interest rates.

What does all this mean?

If you're planning to buy a house, you need to start out the old-fashioned way -- by saving some money.

"As things tighten up, you're going to have to improve your credit quality and save a little bit more money," said Craig Jarrell, president of the Dallas Mortgage Bankers Association.

And make sure you find a lender who won't try to sell you something you can't afford.

Pamela Yip is a columnist for The Dallas Morning News.