Subprime Mortgages
For Americans who have fallen on hard economic times, the motto "nobody knows you when you're down and out" might ring true. This is because conventional lenders often view this category of borrowers as a higher risk due to the latter's troubled credit history and thus preclude them from obtaining financing. Fortunately, the subprime mortgage lending industry exists to serve credit-battered consumers by keeping them financially afloat with the help of mortgage loans. Such individuals may be coping with a divorce, emergency medical care, accumulating debt, unemployment or some other unforeseen circumstance.
Subprime mortgages enable this segment of the population to obtain and utilize credit for a multitude of purposes, including the following:
- Daily expenditures
- Credit card bills
- Purchase of real estate or vehicle
- Refinancing
- Home renovation
Subprime mortgages are also known as near-prime, B-Paper or second-chance mortgages. Typically, subprime candidates have a limited income and a credit score (FICO) under 620 on a scale ranging from 300 to approximately 900. Borrowers of subprime mortgages are labeled credit-risky because of their low credit rating and poor credit history, which is usually a consequence of one or a combination of the following circumstances:
- Late or delinquent loan payments
- Default or non-payment of debts
- Charge-offs
- Foreclosure
- Bankruptcy within the last 7 years
- Judgments
- Repossession
- Diminished repayment ability
The loan rates charged customers differ from one subprime lending institution to the next, depending on the risk-related factors relied upon in granting the loan. This is precisely why borrowers of subprime mortgages are encouraged to engage in comparison-shopping. Some of the criteria that creditors take into consideration when assessing customers' mortgage rates and terms in a process known as "risk-based pricing" are: 1) the down payment amount, 2) types of delinquencies and 3) credit score. With respect to the second factor, lenders of subprime mortgages treat more favorably delinquent credit card payments than overdue rent or mortgage payments.
Subprime mortgage rates are higher than those of prime, A-paper or conventional loans due to the elevated risk associated with a poor credit history. Interest rates on subprime home loans exceed those of traditional loans by at least 2 percentage points. Some subprime mortgages also have balloon payments, prepayment penalties, or both. Prepayment penalties are charges imposed on consumers who pay the loan amount ahead of time, by selling their property or refinancing the loan, for instance. Borrowers with subprime mortgages containing balloon payments must repay the entire loan amount in a lump sum upon the expiration of a specific time period, usually five years. Customers who are unable to pay off the outstanding balance on the balloon payment's due date are required to either sell the home or refinance the loan.
Consumers can choose from among the following three types of subprime mortgages:
1. A mortgage that is interest-only:
Borrowers are permitted to pay only interest for a specific time period (generally 5-10 years)
2. A mortgage that initially has a fixed rate and then changes to variable rate:
The majority of subprime mortgage loans take the form of an adjustable-rate mortgage or ARM. One popular version of subprime home loans is the 2/28 adjustable-rate mortgage or Option ARM. The 2-28 loan starts out with a loan interest rate that remains fixed for two years. On the third year, the loan changes to a higher adjustable rate and fluctuates for the remainder of the term, or 28 years for this particular ARM. Usually, loan rates can change by 2 percentage points at the beginning of the third year and subsequently adjust every six months.
3. A "pick a payment" loan:
Borrowers of these kinds of subprime mortgages can choose from among one of the following monthly payment methods:
- Interest-only
- Minimum payment which may be less than the amount required to lower the loan balance
- Full payment
Compare Mortgage Loan Rates: