CALABASAS, Calif. -- Martin and Cindy Arroyo knew they were not ideal candidates for a home loan.
She had gone through a foreclosure after losing her job, and he was finishing his MBA and had not yet found his current job.
But they had managed to put together a down payment of more than $550,000, or three-quarters of the asking price for a four-bedroom house in Los Gatos, Calif., and thought they would find a bank willing to lend the rest. They didn't.
So the Arroyos found an alternative: a subprime mortgage.
Despite the notoriety that subprime loans gained as a prime cause of the financial crisis, they are re-emerging, under much more careful control, as one answer to the tight lending standards that have shut out millions of would-be homeowners.
"We call it the sane subprime," said Brian O'Shaughnessy, chief executive officer of the Athas Capital Group, which gave the Arroyos their loan.
Subprime loans, which accounted for about 15 percent of all new home loans in 2005 and 2006, are now a tiny sliver of the mortgage market. Only a handful of lenders are offering them, at interest rates from 8 percent to 13 percent (compared with about 4 percent for conventional loans to highly rated borrowers).
O'Shaughnessy said his underwriting standards, while more flexible, are tougher in some cases than those of the Federal Housing Administration, which permits down payments as small as 3.5 percent. According to the Athas rate sheet, borrowers with low credit scores -- between 550 and 600 -- must put at least 35 percent down and will get an interest rate ranging from 8.99 percent to 12.99 percent.
Subprime loans have an unsavory reputation, but they started out with a legitimate purpose: giving people with less-than-stellar credit the ability to buy a home, as long as they paid a premium to compensate for the higher risk.
Traditionally, any loan to someone with a credit score below about 640 has been considered subprime. During the housing bubble, when lenders were hungry for loans to package into securities for resale, the subprime label expanded to describe all manner of schemes, including loans with low or no down payments, "liar loans" with no proof of income and loans with a monthly payment so low that the principal actually increased over time.
Those exotic products are now virtually extinct. Governed by an encyclopedia's worth of new regulations, Athas' loans generally require down payments of at least 20 percent and documentation of income or assets, as well as an assessment of the borrower's ability to make the payments.
Athas does not offer teaser rates, pick-a-payment options or interest-only payments. But it does offer loans to people whose records are marred by a recent foreclosure or who lack a steady income.
And it is doing just what many economists and consumer groups have urged: making credit more widely available.
"Not all subprime lending is abusive. It just happened that all of the abuses happened in the subprime space," said Nikitra Bailey, an executive vice president of the Center for Responsible Lending. "The regulators now have to be really vigilant to make sure people are getting appropriate loans, and they don't allow the subprime market to get back out of hand."
Marketed by some lenders as "second-chance mortgages," only about 0.5 percent of new home loans are subprime today, according to Black Knight Financial Services, a research firm for lenders.
More than 12.5 million people who might have qualified for a home loan before the crash have been shut out of the market, Mark Zandi, the chief economist for Moody's Analytics, estimates. Members of minority groups have especially suffered; blacks and Hispanics are rejected by mortgage lenders far more often than whites.
The vocabulary of subprime mortgages has changed. Because new federal regulations have created something called a qualified mortgage, which must conform to strict requirements, future lending is likely to be categorized as a qualified mortgage or nonqualified mortgage rather than prime or subprime. Nonqualified mortgage lenders will have both more flexibility and more liability but not all nonqualified mortgage loans will be subprime.
Among the lenders preparing to make nonqualified mortgage loans is New Leaf Lending, a division of the Skyline Financial Corp., based in Calabasas, Calif., and run by William Dallas. In 2007, Dallas was a subprime lender who said that investors had pushed him to make risky loans.
"The market is paying me to do a no-income-verification loan more than it is paying me to do the full-documentation loans," he said. "What would you do?"
Now, he said, the pendulum has swung too far the other way.
"If you're self-employed, you're hosed," Dallas said. "If you just started a job, you're hosed. If you get a bonus, you're hosed. Just got a severance payment? Can't count that. I don't have to do a lot to be a lender. I just have to be normal."
A Section on 06/29/2014