What is a subprime mortgage?

Subprime mortgages are home loans for borrowers with a low credit score, often less than 600, which prevents them from qualifying for a loan. conventional loan. These generally carry higher interest rates and down payment requirements than conventional loans. Widely blamed for fueling the Great Recession, subprime mortgages now exist as subprime mortgages under stricter rules, but they are still risky and generally not the best type of loan to take out.

How do subprime mortgages work?

Synonymous with the Great Recession, subprime mortgages took on a new name following the 2008 financial crisis. Subprime mortgages, as they are called today, are regulated by the Consumer Financial Protection Bureau (CFPB ), which established new rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

One of those rules: Before a lender can issue a subprime or non-subprime mortgage, borrowers must follow home buying advice through a Department-approved representative. American Housing and Urban Development (HUD). In addition, lenders must take out subprime mortgages in accordance with standards set by Dodd-Frank.

According to CFPB rules, some subprime mortgages fall into a new non-qualifying mortgage loan Category. This designation limits legal protections for lenders, so they are also potentially risky for the lender.

“Lenders are not making the same types of subprime loans as they are approaching the Great Recession,” says Austin Kilgore, director of digital lending at Javelin Strategy & Research. “The main reason is the regulatory issues.”

Subprime Mortgage Rules

Kilgore notes that Dodd-Frank’s “repayment capacity” (ATR) provision requires lenders to go through a thorough process to determine if potential borrowers are able to repay the loan on terms.

“If you break the ATR rule as a lender, you can potentially be sued or subject to law enforcement,” Kilgore said. “So lenders who operate in the unskilled mortgage industry have a strong incentive to ensure that they are adequately rating borrowers much more than the subprime lenders of 15 to 20 years ago. “

The CFPB periodically reviews the rules and makes changes when it deems necessary.

Dodd-Frank in general has also been criticized by some. In 2018, Congress voted to strike down parts of the law. While these changes did not erode or directly affect the provisions designed to protect consumers from subprime and subprime mortgages, they did add an additional layer of uncertainty to an already risky loan.

Subprime mortgage risks

Since subprime mortgages are generally granted to borrowers with low credit scores, these loans increase the risk for the lender. To offset this risk, the lender may charge higher interest rates and fees than you might see on a conventional loan. Current 30-year fixed mortgage rates hover around 3%, but subprime mortgages can have interest rates as high as 10%.

House price Advance payment Interest rate term of the loan Monthly mortgage payment Total interest
$ 200,000 20% ($ 40,000) 3% 30 years $ 674 $ 82,970
$ 200,000 20% ($ 40,000) ten% 30 years $ 1,404 $ 345,699

In addition, subprime or non-risk mortgages generally require larger down payments than their conventional counterparts. In the above scenario, a 20% down payment equals $ 40,000, but the down payment requirements on subprime mortgages can be as high as 35%. In this example, this equals $ 70,000.

In addition, the terms of subprime mortgages may stretch longer than usual. Most conventional loans are designed to pay off in 15 or 30 years, but some subprime mortgages can last 40 or 50 years. The longer you pay off your mortgage, the more interest you will pay over the life of the loan. It could mean paying tens or hundreds of thousands more than if you had taken out a conventional 15 or 30 year mortgage.

Types of subprime mortgages

Subprime and subprime mortgages work the same way as conventional mortgages. Here are some of the different types of subprime mortgages:

Subprime Fixed Rate Mortgage

A subprime fixed rate mortgage works like a conventional fixed rate mortgage in that the borrower gets a fixed interest rate and the monthly payment stays the same for the duration of the loan repayment period. The difference is that subprime fixed rate mortgages sometimes have longer terms, such as 40 or 50 years, compared to the typical 15 or 30 years for a conventional fixed rate loan.

Subprime Variable Rate Mortgage (ARM)

There are also subprimes adjustable rate mortgages, or ARM, like ARM 3/27, in which the borrower gets a fixed interest rate for the first three years and then the rate is readjusted for the remaining 27 years. Rate adjustments are based on the performance of a market index plus a margin. Most lenders have a cap on how much your rate can increase, but if you can’t make the maximum monthly payment, you could be at risk of default.

Interest only loan

With a interest only loan, the borrower only pays interest in the first few years, usually seven or ten. This could mean lower monthly payments at the start, but no upfront repayment of loan principal and delayed equity.

The mortgage of dignity

With a dignity mortgage, the borrower makes a down payment of at least 10 percent and takes a high interest rate. If the borrower makes payments on time for a certain period, usually five years, the amount paid for interest is used to reduce the loan balance, and the interest rate is lowered to preferential rate, or the rate that most big banks charge their most creditworthy borrowers. This rate is largely determined by the federal funds rate set by the Federal Reserve. You can only benefit from this type of mortgage if you can afford to make larger payments at the start of your term.

Should you take out a subprime mortgage?

Probably not. High interest rates make subprime mortgages a loan of last resort.

The good news is, even if your credit history is in tatters, a subprime mortgage isn’t your only option. Many government guaranteed mortgages, including FHA loans and VA loans – are designed to help borrowers with credit problems. If you are a first-time home buyer, there are many first-time home purchase assistance programs, as well as.

Alternatives to a subprime mortgage

If you are considering taking out a subprime or subprime mortgage because of your credit history, know that this is not your only option. Many government guaranteed mortgages are designed to help people with less than good credit. They also tend to have lower interest rates than conventional loans.

  • FHA loans: If your credit score is at least 580, consider an FHA loan with a 3.5% down payment. If your credit score is between 500 and 579, you are eligible for an FHA loan with 10% down payment.
  • AV loans: If you are a veteran or an active member of the military, consider VA loans. Guaranteed by the US Department of Veterans Affairs, these loans require no down payment and have no minimum credit score requirement.
  • USDA Loans: USDA loans are designed for low to moderate income borrowers in designated rural areas. (Some eligible locations are near major metropolitan areas.) While some lenders may have a minimum credit score for USDA loans, others may have relatively lenient standards that can help you qualify.

At the end of the line

Subprime or non-subprime mortgages are for borrowers who may not have sufficient credit to qualify for a conventional loan, but they tend to come with higher interest rates and lower rates. ‘down payment requirements. In the long run, you could be paying a lot more than you would with any other type of loan. Before applying for a mortgage, consider improve your solvency to benefit from a better rate and better conditions.

Either way, it’s important to shop around and compare mortgage rates to find the best loan for your situation.

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