Your credit report and ultimately your credit rating is one of the key things lenders look at to figure out if you’re credit worthy or not.
Potential borrowers with high credit ratings are easily approved for mortgages because they are considered to be creditworthy and they pose less risk to lenders. As such, they get the lowest loan interest rates.
In contrast, potential borrowers with low credit scores are viewed as high risks to lenders because they have unhealthy financial histories. As such, they are required to pay the highest interest rates in the market.
However, to make it easier for potential borrowers with a dent on their credit ratings to get a loan or to be eligible for a mortgage, subprime mortgages were introduced.
What Exactly Is A Subprime Mortgage?
A subprime mortgage is the type of mortgage that is typically offered to potential borrowers with poor credit scores.
Because the lender considers the potential borrower to be a higher-than-average risk individual who is more likely to default on the loan, such borrower will not be offered a prime conventional mortgage.
Lenders typically charge a higher interest rate on subprime mortgages than a prime mortgage and they argue that this is done to cover for taking more risk because of the borrowers’ unhealthy credit history.
Subprime mortgages are also usually adjustable rate mortgages (ARMs). This means the interest rates can rise at any time.
Under the law, lenders are not mandated to provide you the best option of mortgage available or make you aware that they exist.
As such, you should consider applying for a prime mortgage first to find out if you’re really eligible or not.
How Subprime Mortgages Work
It is easy to assume that subprime is used to indicate the interest rates borrowers are expected to pay for the mortgage. Rather, subprime is used to describe the credit score of the potential borrower who intends to take out a mortgage.
If you’re a borrower with a credit score that is lower than 600, your only mortgage option could be subprime mortgages as well as their higher interest rates.
As such, it is important for consumers with low credit scores to take some time to repair their credit and rebuild their credit histories before seeking out a mortgage so they can be eligible for prime mortgages.
The high interest rates that are tied to subprime mortgage are based on four key metrics.
- Credit score
- Down payment amount
- How many late payment appear on a potential borrower report
- Other types of anomalies that appear on the report
Key Differences between A Subprime Mortgage And A Prime Mortgage
Generally, mortgage consumers are rated from A to F. The A rate is assigned to consumers with outstanding credit ratings.
The F for those with low credit rating and those considered high risk in terms of borrowing. They can easily default on their loan payment.
As such, A and B candidates are automatically eligible for prime mortgages. On the other hand, candidates rated C, D, and F only end up with subprime mortgages if they will be eligible for any loan.
Important Things To Note
- The term “subprime” indicates the less than average credit rating of the borrower seeking out a mortgage showing that he is not very creditworthy.
- Subprime mortgages typically come with higher interest rates to offset the high risks lenders have to bear for providing loans to borrowers with the potential not to repay.
- For the most part, the 2008 financial meltdown have been held responsible for the excessive subprime mortgages given to non-eligible borrowers which triggered the real estate crisis.
How Subprime Mortgages Partly Triggered The Housing Market Crash
The housing market meltdown in 2008 was somewhat because many borrowers inability to pay back their subprime mortgages. This was also mostly because many of such borrowers were offered what was referred to as No Income No Job No Assets (NINJA) loans.
These NINJA mortgages were typically offered without any form of a down payment as a prerequisite. Also, evidence of borrowers’ income was not considered mandatory.
Any buyer can easily lie that they earn $200,000 per year without any evidence to back up such a statement.
Many of such borrowers ended up underwater in a failing real estate market – with the values of their properties lower than what is left of their mortgage.
Even more, several NINJA borrowers couldn’t pay back because the interest rates tied to their loans were “teaser rates” – these are changing rates that kicked off as low rates and then snowballed over time into higher rates.
As such, many borrowers couldn’t pay down the principal on their mortgage.
In 2015, some financial houses including Bank of America, and Wells Fargo announced their intention to start providing mortgages to people with credit scores that are in the range of 600s.
If your credit rating is not good enough for a prime mortgage, you should consider repairing your credit score by yourself or see what a credit repair company can do for you.
If possible, which is likely in many cases, avoid seeking a subprime mortgage because of its high interest rate.
Rather, wait for some period of time while rebuilding your credit and then ascertain that your credit score is high enough for you to be eligible for a prime mortgage.
It is better to wait for your credit rating to improve before seeking a mortgage loan rather than end up with a high interest loan that could leave you at risk of a foreclosure.