What is a 'Subprime Mortgage'
A subprime mortgage is a type of mortgage that is normally issued by a lending institution to borrowers with low credit ratings. As a result of the borrower's lower credit rating, a conventional mortgage is not offered because the lender views the borrower as having a larger-than-average risk of defaulting on the loan. Lending institutions often charge interest on subprime mortgages at a rate that is higher than a conventional mortgage in order to compensate themselves for carrying more risk.
BREAKING DOWN 'Subprime Mortgage'The term "subprime" is thought to refer to the interest rate attached to a mortgage. If a mortgage is considered subprime, people usually assume that it is denoting that the interest rate is high. However, subprime actually refers to the credit score of the individual taking out the mortgage. The size of the interest rate associated with a subprime mortgage is dependent on four factors, in order of importance: credit score, the size of the down payment, the number of late payment delinquencies on a borrower's credit score and the types of the delinquencies.
Therefore, borrowers with credit ratings below 600, for example, will often be stuck with subprime mortgages and higher interest rates to go along with those mortgages. Additionally, making late bill payments or declaring personal bankruptcy could very well land borrowers in a situation in which they can only qualify for a subprime mortgage. Thus, it is often useful for people with low credit scores to wait for a period of time and build up their scores before applying for mortgages, to ensure they are eligible for a conventional mortgage.
An Example of the Rise of Subprime Mortgages
For those who remember, the 2008 market crash and housing crisis was due in large part to wide-spread defaulting on subprime mortgages. Essentially, many borrowers were given what has been come to be called NINJA loans, which are mortgages given to people with no income, no job and no assets. Often times, these mortgages were issued with no down payment. Then, these borrowers found themselves underwater in a declining housing market, with their home values lower than the mortgage they owed. Many of these NINJA mortgages defaulted because the interest rates associated with the loans were called "teaser rates," which were variable interest rates that started low and ballooned over time, making it very hard to pay down the principle of the mortgage.
However, potential subprime mortgages are again on the rise. As of June 2015, Wells Fargo, Bank of America, and other financial institutions reported that they would begin offering mortgages to individuals who had credit ratings in the low 600s.