Clawing Your Way Out of the Subprime and Alt-A Market

Updated on March 21, 2008.

WITH MORTGAGE DELINQUENCIES and foreclosures dominating the news these days, hopeful homeowners are left wondering about their chances of getting a mortgage.

To be sure, the rules of lending have changed. Most folks find themselves subject to stricter requirements, from having to put larger down payments down to being asked for more detailed proof of their income and assets. Others can't qualify for mortgages at all. Yet, attractive loans are still around for those with the best credit histories and qualifications.

Which group you fall in is determined by your credit profile and the type of loan you're hoping to get. Or to put it in industry-speak, it all depends on whether you're a prime, "Alt-A" or subprime borrower.

To help you determine what this mortgage market means for you, we've prepared a quick tutorial on the different types of borrowers, along with tips on improving your chances of qualifying for a mortgage. Here's what you need to know.

* Prime
You are considered a prime, or A-credit quality, borrower if your score is above 680, and especially above 720, explains Keith Gumbinger, a vice president at HSH Associates, a Pompton Plains, N.J., mortgage information firm. (You're still considered a prime borrower if your score is between 680 and 720, but you won't qualify for rates as attractive as those available to consumers with scores of 720 or more.) Needless to say, the higher your score, the more "prime" you are and the better loan terms you'll be offered. You'll also need to show documentation (tax returns, pay stubs, and brokerage account statements) confirming your income and your assets. And, your total debt-to-income ratio, which compares your monthly gross income to your monthly debt payments, can't exceed some 42%. (In recent years, those ratios had extended as high as 55%.) Prime borrowers are also those who put down payments of at least 5% or 10%, have several months' worth of mortgage payments in the bank after purchasing their home, and can document their income. But in places where real estate prices have fallen drastically, like Miami and Las Vegas, you'll need a downpayment of at least 15% to 20%, says Gumbinger.

* Alt-A
This is one step down on the mortgage ladder. The number of lenders willing to work with Alt-A borrowers has dropped significantly in the past few months, says Neil Sullivan, president of Westfield Mortgage, a New Jersey-based mortgage broker. Alt-A borrowers typically have prime-quality credit scores, of 620 or above, Gumbinger explains, but have some kind of "defect" in their borrowing profile. This may be the lack of savings, for example. Or they may be self-employed and therefore need a stated-income loan, which doesn't require proof of income. They may also have higher debt-to-income ratios: lenders traditionally like to see total housing obligations — mortgage payment, insurance, taxes and maintenance costs — that don't exceed 36% of a borrower's gross monthly income. (So, that's 36% out of a maximum 42% total debt-to-income ratio that you can have in order to qualify.) Finally, you may be qualified as an Alt-A borrower if you have little or no assets such as savings or investments left over after purchasing your home.

* Subprime
You're a subprime borrower if your credit score is less than 620. Unfortunately, there's no good news for subprime borrowers right now. "This market has dried up," says Gumbinger. Even if you get approved for a mortgage - the probability of this is very low - you'll get hit with a very high interest rate and with strict and unrealistic requirements, like a 50% downpayment or a six-figure salary, says Gumbinger. Instead, put a pause on your house search and focus on improving your credit score. Only then will you be able to move up the borrower's ladder. Click here for tips on boosting your credit score.

Tighter FICO score requirements will have the biggest impact on folks in the subprime and Alt-A groups, mortgage brokers say. "Some lenders used to do loans at 580 or 620 scores, and those thresholds have moved up to 680 or 700 and above," says Sullivan. This means folks in the subprime category might not be able to find loans at all.