A:

A subprime mortgage is a type of loan granted to individuals with poor credit histories (often below 600), who, as a result of their deficient credit ratings, would not be able to qualify for conventional mortgages. Because subprime borrowers present a higher risk for lenders, subprime mortgages charge interest rates above the prime lending rate.

There are several different kinds of subprime mortgage structures available. The most common is the adjustable rate mortgage (ARM), which initially charges a fixed interest rate, and then convert to a floating rate based on an index such as LIBOR, plus a margin. The better known types of ARMs include 3/27 and 2/28 ARMs.

ARMs are somewhat misleading to subprime borrowers in that the borrowers initially pay a lower interest rate. When their mortgages reset to the higher, variable rate, mortgage payments increase significantly. This is one of the factors that lead to the sharp increase in the number of subprime mortgage foreclosures in August of 2006, and the subprime mortgage meltdown that ensued. (To learn more, read The Fuel That Fed The Subprime Meltdown.)

Many lenders were more liberal in granting these loans from 2004 to 2006 as a result of lower interest rates and high capital liquidity. Lenders sought additional profits through these higher risk loans, and they charged interest rates above prime in order to compensate for the additional risk they assumed. Consequently, once the rate of subprime mortgage foreclosures skyrocketed, many lenders experienced extreme financial difficulties, and even bankruptcy.

For more information, read Subprime Lending: Helping Hand Or Underhanded?

RELATED FAQS
  1. How much risk is associated with subprime mortgages?

    Discover the risks associated with subprime mortgages. Find out whether taking out a subprime mortgage on your home is really ... Read Answer >>
  2. Are Subprime Mortgages Still Available for Homeowners?

    Buying homes became increasingly difficult after the housing bubble burst. Since then, subprime mortgages have been making ... Read Answer >>
  3. What are the different types of subprime mortgages?

    Clarify your understanding of subprime mortgages. Learn about the different types, how they work and when they might be beneficial. Read Answer >>
  4. What is the difference between a 2/28 and a 3/27 ARM?

    An adjustable rate mortgage (ARM) is a type of mortgage that has a fixed interest rate for a certain time period at the beginning ... Read Answer >>
  5. What is a liquidity squeeze?

    A liquidity squeeze occurs when a financial event sparks concerns among financial institutions (such as banks) regarding ... Read Answer >>
Related Articles
  1. Personal Finance

    What is a Subprime Mortgage?

    Subprime mortgages are offered to borrowers with low credit ratings, usually 600 or below.
  2. Investing

    Subprime Lending: Helping Hand Or Underhanded?

    These loans can spell disaster for borrowers, but that doesn't mean they should be condemned.
  3. Investing

    Subprime Is Often Subpar

    Proceed with caution when considering these short-term, high-interest mortgages.
  4. Investing

    Who Is To Blame For The Subprime Crisis?

    From lenders to buyers to hedge funds, it appears everyone has blood on their hands.
  5. Personal Finance

    Finding the Best Mortgage Rates in 2017

    As home-buying technology has progressed, the process of finding the best mortgages rates can all be done online. Here's how:
  6. Investing

    The Next Big Short: Subprime Auto (NICK)

    Economists are increasingly concerned about the subprime loan industry. But this $1.1 trillion bubble has nothing to do with housing.
  7. Investing

    Back to the Future: AAA Bonds Backed by Risky Debt

    Bonds backed by risky mortgage loans received AAA ratings by two ratings agencies less than ten years after the subprime crisis
  8. Insights

    The 2007-08 Financial Crisis In Review

    If you don't know how the recession began, read on to learn more.
  9. Small Business

    The 2007-08 Financial Crisis In Review

    Subprime lenders began filing for bankruptcy in 2007 -- more than 25 during February and March, alone.
  10. Personal Finance

    5 Risky Mortgage Types To Avoid

    There are plenty of ways to end up with a bad mortgage. The risks of these five should make every homebuyer think twice before signing.
RELATED TERMS
  1. Subprime Mortgage

    A type of mortgage that is normally made out to borrowers with ...
  2. Subprime Market

    The market for lenders and borrowers of subprime credit, a credit ...
  3. Subprime Rates

    Interest rates charged to subprime borrowers, such as on loans ...
  4. Subprime Borrower

    A person who is considered a higher-than-normal credit risk. ...
  5. Subprime Loan

    A type of loan that is offered at a rate above prime to individuals ...
  6. ABX index

    A financial benchmark that measures the overall value of mortgages ...
Hot Definitions
  1. Benchmark

    A standard against which the performance of a security, mutual fund or investment manager can be measured.
  2. Mobile Wallet

    Mobile wallet is a virtual wallet that stores payment card information on a mobile device.
  3. Leverage

    1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. ...
  4. Trumponomics

    Trumponomics is a term for the economic policies of President Donald Trump.
  5. Universal Health Care Coverage

    An organized healthcare system that provides healthcare benefits to all persons in a specified region. Many countries, such ...
  6. Davos World Economic Forum

    The annual meeting of the World Economic Forum hosted at Davos—a small ski town in Switzerland—in January each year is among ...
Trading Center