What is a subprime mortgage?

By Shauna Carther AAA
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?

(For a one-stop shop on subprime mortgages and the subprime meltdown, check out the Subprime Mortgages Feature.)

RELATED FAQS

  1. When did the real estate bubble burst?

    Collapsing home prices from subprime mortgage defaults and risky investments on mortgage-backed securities burst the housing ...
  2. What's the difference between a secured line of credit and an unsecured line of credit?

    Discover the differences between a secured line of credit and an unsecured line of credit, and why lenders treat the two ...
  3. How does refinancing my mortgage affect my FICO score?

    Learn some of the ways refinancing your mortgage could impact your FICO credit score, especially if you have held your current ...
  4. What are the differences between a home equity line of credit (HELOC) and a home ...

    Learn the differences between a home equity loan and a home equity line of credit, and find out how to select the one that ...
RELATED TERMS
  1. Forbearance

    A temporary postponement of mortgage payments.
  2. Mortgage Modification

    A permanent change in a homeowner's home loan terms that makes ...
  3. USDA Non-Streamlined Refinancing

    A mortgage-refinancing option offered by the United States Department ...
  4. No-Appraisal Mortgage

    A type of home loan used for refinancing for which the lender ...
  5. No-Appraisal Refinancing

    A type of mortgage for which the lender does not require an independent, ...
  6. No-Appraisal Loan

    A mortgage that does not require an appraisal of the property’s ...
Related Articles
  1. How Our Borrowing Habits Have Changed ...
    Credit & Loans

    How Our Borrowing Habits Have Changed ...

  2. Buying A Home: Cash Vs. Mortgage
    Credit & Loans

    Buying A Home: Cash Vs. Mortgage

  3. The 4 Worst Reasons For A Cash Advance
    Credit & Loans

    The 4 Worst Reasons For A Cash Advance

  4. Steps To Buy A Home
    Home & Auto

    Steps To Buy A Home

  5. How Does A Reverse Mortgage Work?
    Retirement

    How Does A Reverse Mortgage Work?

Trading Center