What Is a Subprime Mortgage?

A subprime mortgage is one that’s normally issued to borrowers with low credit ratings. A prime conventional mortgage isn’t offered, because the lender views the borrower as having a greater-than-average risk of defaulting on the loan.

Lending institutions often charge interest on subprime mortgages at a much higher rate than on prime mortgages to compensate for carrying more risk. These are often adjustable-rate mortgages (ARMs) as well, so the interest rate can potentially increase at specified points in time.

Key Takeaways

  • “Subprime” refers to the below-average credit score of the individual taking out the mortgage, indicating that they might be a credit risk.
  • The interest rate associated with a subprime mortgage is usually high to compensate lenders for taking the risk that the borrower will default on the loan.
  • The 2008 financial crisis has been blamed in large part on the proliferation of subprime mortgages offered to unqualified buyers in the years leading up to the meltdown.

Understanding Subprime Mortgages

“Subprime” doesn’t refer to the interest rates often attached to these mortgages, but rather the credit score of the individual taking out the mortgage. Borrowers with FICO credit scores below 600 will often be stuck with subprime mortgages and their corresponding higher interest rates. It can be useful for people with low credit scores to wait for a period of time and build up their credit histories before applying for a mortgage, so they might qualify for a prime loan.

The interest rate associated with a subprime mortgage is dependent on four factors: credit score, the size of the down payment, the number of late payment delinquencies on a borrower’s credit report, and the types of delinquencies found on the report.

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Subprime Mortgage

Subprime Mortgages vs. Prime Mortgages

Mortgage applicants are typically graded from A to F, with A scores going to those with exemplary credit, and F scores going to those with no discernible ability to repay a loan at all. Prime mortgages go to A and B candidates, whereas lower-rated candidates must typically resign themselves to subprime loans if they’re going to get loans at all.

Lenders aren’t legally obligated to offer you the best available mortgage terms or even let you know that they’re available, so consider applying for a prime mortgage first to find out if you do indeed qualify.

An Example of the Effect of Subprime Mortgages

The 2008 housing market crash was due in large part to widespread defaults on subprime mortgages. Many borrowers were given what were known as NINJA loans, an acronym derived from the phrase “no income, no job, and no assets.”

These mortgages were often issued with no down payment required, and proof of income was not necessary either. A buyer might state that he or she earned $150,000 a year but did not have to provide documentation to substantiate the claim. These borrowers then found themselves underwater in a declining housing market, with their home values lower than the mortgage they owed. Many of these NINJA borrowers defaulted because the interest rates associated with the loans were “teaser rates,” variable rates that started low and ballooned over time, making it very hard to pay down the principal of the mortgage.

Wells Fargo, Bank of America, and other financial institutions reported in June 2015 that they would begin offering mortgages to individuals with credit ratings in the low 600s, and the nonprofit, community advocacy, and homeownership organization Neighborhood Assistance Corporation of America launched an initiative in late 2018, hosting events nationwide to help people apply for “non-prime” loans, which are effectively the same as subprime mortgages.

The CARES Act Gives Some Mortgage Relief

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law by the president on March 27, 2020, provides some temporary relief to people who find themselves unable to make their mortgage payments due to the coronavirus pandemic. If your mortgage is backed by the federal government, you can suspend payments for up to 12 months. You will not be charged late fees or reported to credit bureaus, and all foreclosures and evictions will be suspended for at least 60 days. After the 12 months are up, you may be eligible for additional help if you need it.