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 larger-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.
[Important: 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.]
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 credit ratings 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 first before applying for a mortgage so they might potentially 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 score, and the types of the delinquencies found on her credit report.
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 C and F candidates must typically resign themselves to subprime loans if they're going to get loans at all.
- "Subprime" refers to the below-average credit score of the individual taking out the mortgage, indicating that he 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 nonqualified buyers prior to that time.
An Example of the Effect of Subprime Mortgages
These mortgages were often issued with no down payment required, and proof of income was not necessary either. A buyer might state that she earned $150,000 a year but did not have to provide documentation to substantiate her 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 principle of the mortgage.
Wells Fargo, Bank of America, and other financial institutions reported in June 2015 that they would begin offering mortgages to individuals who had credit ratings in the low 600s, and the Neighborhood Assistance Corporation of America launched an initiative in late 2018, hosting events coast to coast to help people apply for "non-prime" loans, which are effectively the same as subprime mortgages.