Shamrock Financial Corporation

‘Can you believe we’re still doing loans for people with only 3% down? Didn’t we learn anything? I was greeted with this common question at a recent luncheon of real estate professionals and it popped me right back to lessons-learned and tales-told from my first year in the consumer lending industry…1985.

Back then, we all learned that the basic tenants of lending decisions were based on The 3 C’s: Character, Capacity and Collateral.

A refresher course:

Character: Quite simply, did the applicant pay their bills on time. We use to grade them like school A, B, C, D. If you were a C or D you were an easily denied; if you were an A or B we considered the next C.

Capacity: Did the applicant make enough money to afford the new payment, especially when considering the other things he or she had to pay each month? If so, we looked at the third and most important C.

Collateral: Did the applicant have enough equity in their property (refinance) or would they be creating enough equity in the way of a down payment (purchase) to make their collateral sufficient enough to absorb risk for the lender.

Now, the industry cleverly hedged bets against one C if another C went lacking a bit. We just made sure to price the note a little higher and collect it (“Hello Mr/Mrs Borrower, your payment will be late as of next week”) a little stronger. Delinquency rates were always modestly offset by higher yields and by more “personalized” collection efforts, along with adjustments made in the requirements of the remaining two C’s. This model served everyone quite well for a long time.

The carpenter, waitress, hair-dresser or any other member of the “underground” economy could qualify for a loan without documented “Capacity” by being required to have BETTER Character (higher credit score) and better Collateral (more equity/higher down payment). By the same token, the B-credit guy who might otherwise have been rejected was also approved if their equity position could ease the risk. More money down cured a lot of sins.

Unfortunately, this all ended with the free-for-all of rising market values that fostered the no-money down frenzy. Collateral was essentially removed from the Three C’s because it became like the weather in New England: If you don’t like it, just wait for tomorrow, it’ll change. And since that change was UPWARDS, who cared about Collateral, and for that matter, the other two C’s didn’t matter much either. The whole notion of “skin in the game” was lost at sea.

We then “bundled” all these loans into securities and lost that “personalized” collection touch. Prescription for disaster: Filled.

Now back to the original question posed at my luncheon; “haven’t we learned that you can’t lend with only 3% down? Um, yes and no, I guess”… You see, the trouble today is that we have thrown the baby out with the bathwater. We have abandoned the basic lessons the Three C’s taught us long ago. So yes, you can allow an applicant to put just 3% but the other two C’s must be very, very strong. And just as importantly, you can lend to the person who doesn’t disclose all their income (code for not paying all their taxes, BTW). Just make sure they put 20% down!

The guy who misses payments now and again? Sure, lend to him too, just make sure his Capacity is excellent and his down payment/equity is high too. Oh, and don’t give them the lowest of all rates like a true Three C’s applicant. Bump it a full point. i.e.: 6% instead of 5%.

We can do this. We can return to a traditional market. We just can’t do it without some understanding of what a traditional market loved most: It’s 3 C’s.