Well, it happened; the #1 subprime loan, what we in the mortgage business affectionately refer to as the 2/28 (2 years fixed, 28 years adjustable), also known as a band-aid loan, is no more. 2/28 swims with the fishes boys and girls, and it’s another notch on the belt of the subprime grim reaper.

It happened earlier this week, but who cares, right? What we really care about is understanding the 2/28 and it’s significance in the subprime industry, so here goes nothin’.

If you’ve ever heard the term, “Band-Aid Loan,” you’ve been affected by the 2/28. For borrowers with poor credit histories, it doesn’t make any sense to get a 30-year fixed at the rate they’d qualify for; around 3-5% higher than an A-Paper borrower would qualify for. Generally, the shorter the fixed term, the lower the interest rate; so where a subprime borrower may have qualified for 8.5% on a 30-year fixed mortgage, they’d qualify for 7.5-8% on a 2/28.

That’s good and bad. Why you ask? Well, I’ll tell you. The good side is this…The 2/28 allowed a subprime borrower to have a lower payment than he or she would on a 30-year fixed. Two years just happens to be about the time it takes to repair major credit problems and qualify for semi-decent interest rates. Hence the name Band-Aid Loan. The goal was to put the borrower on a 2/28, wait two years while credit scores increased enough to get a decent rate on a mortgage, and refinance into a 30-year fixed. A solid plan, no doubt, but it’s not all peaches and cream.

Mortgage Brokers have a pretty poor reputation these days, and, it saddens me to say this, but rightfully so. I know a lot of people in this business, and less than half of them have their clients best interests at heart. The good thing is, with the recent mortgage market downturn, a lot of these people, who were only around because they thought they could get rich quick, are dropping like flies. But I’m getting off topic…

The bad part of the infamous 2/28 is the nature of many subprime borrowers. Let me add a disclaimer: I think all people are individuals; I’ve always been against any line of thinking that categorizes or groups people as if they were machines. However, one thing I’ve learned in this industry is the things that make people unique are the small, personal details and when dealing with large numbers of people, the person who assigns stereotypes is more likely to be correct than the person who doesn’t. I know this isn’t popular opinion, but I’m not hear to mince words, I’m hear to tell you everything I know. I can get into this in more detail in another post, but you haven’t heard a stereotype until you’ve sat in on a sales or marketing meeting. Anyway, I’m drifting again…back to the point.

The vast majority of people with poor credit do not clean things up; it’s the truth. I’ve done a lot of loans for subprime borrowers…near 150. Out of 150 borrowers, 1 has become an A-Paper borrower. That’s right…1. I do everything I can to put my clients into a better financial position; I call them 6 times a year to check in and ensure they’re sticking to the plan we laid out. When interest rates adjust or a new program comes out I review past client files to see if we can improve things even further. Even so, around 149 of my subprime clients were in the exact same situation year after year. No matter what I told them, they continued to rack up credit card debt or purchase cars they couldn’t afford. The fact that the 2/28 was so popular in the past is largely due to the fact that mortgage professionals understand this. I mean, what better way to make money than put a client into a high interest-rate loan with high fees, knowing that in 2 years that loan is going to adjust and the client is going to have to refinance again; and like I explained, only 1 out of those 150 will be in a situation where the broker couldn’t get away with charging an arm and a leg.

The fact is, the 2/28 is an example of a perfect concept that fails miserably in practice.

So what’s the point of all this? If you’re a subprime borrower I hope this post inspires you to really crack down, understand what it is you want in life, and be willing to do whatever it takes to get there. I’ve been through real financial problems in the past, so I understand how that can be…always remember that you can become whatever you want. For those A-Paper readers; the purpose of this post is to make you better informed.

Do not…for the love of God, do not end your reading of this post with a sense of pessimism. There are a lot of really good people out there and there are a lot of incredible mortgage brokers out there. Unfortunately, so few people know enough about finance that the entire subprime industry is in shambles…well, that’s why I started this blog…to keep good people who don’t understand the details from being taken advantage of.

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