Subprime mortgage rates are interest rates that are charged for home loans to people who do not qualify for standard home loans. The primary reasons people are turned down for standard mortgages are poor credit scores, which are typically below 620. As people with poor credit scores are considered higher risks than those with good credit scores, subprime mortgage rates are higher than standard mortgage rates.
Function
The purpose of a subprime mortgage is to allow those who would not otherwise qualify for a home loan the opportunity to purchase a house. Those with low credit are the primary customers of subprime lenders, although the inability to come up with a down payment or a high debt-to-income ratio could also be factors that disqualify people from standard loans and have them applying for subprime loans.
Rates
Interest rates vary from lender to lender much more in the subprime mortgage industry than they do with standard mortgages. Different subprime mortgage companies weigh the risk of the loan differently, which will lead to different rates. In 2004, the mortgage rate for a conventional fixed rate loan was roughly 6 percent. Subprime mortgages varied between 7 and 10 percent, depending on the grade given the applicant. A subprime mortgage lender looks at the same items as a conventional lender, such as credit score, income and debt.
Features
Many subprime loans will have prepayment penalties, as many subprime borrowers either sell their homes or seek refinancing at a lower interest rate. Balloon payments are also common in the subprime mortgage industry. With a balloon payment, the borrower must pay off the loan within a specified period of time, which is usually less than 10 years. If the loan can't be repaid, the borrower may sell the house or seek refinancing to pay off the balloon payment.
Identification
Subprime lenders do not typically advertise themselves as such, which has led some people who could have qualified for a conventional loan to take a subprime loan at less-favorable terms. The terms offered by the lender are often the only way to detect a subprime lender. Subprime lenders will justify the higher costs by pointing out that a larger percentage of subprime loans go into default and that more loan applications are rejected, which leads to higher administrative costs per loan.
Types
While the 5/25 ARM is popular for conventional home loans, the subprime market often used a 2/28 adjustable rate in which the mortgage payment was fixed for two years and then adjusted. It is common to use the prime rate as the index with a margin of 5 percent. If the prime rate was 6 percent at the end of the two-year period, the subprime borrower would see their new interest rate jump to 11 percent, while the interest on a conventional mortgage would be closer to 6.25 percent.
Prevention/Solution
The subprime mortgage industry was affected by falling housing prices that began in 2006. As interest rates climbed, many subprime borrowers defaulted on their loans, which drove dozens of subprime lenders out of business. As of 2009, the subprime mortgage industry had nearly vanished completely.
Member Comments