It may have been a couple late payments or something as bad as a bankruptcy, but whatever the problem, the outcome is the same: A scarlet letter on the credit report and an “Application Denied” stamp from the mortgage lender.

The bad-credit problem traps plenty of people, but a booming business among so-called “subprime” lenders means money likely will be available to those looking to move into a new home or refinance to consolidate debt.

Think about it

But experts caution people to carefully weigh the benefits and drawbacks of taking out a subprime loan. Having one and handling it well can help repair a damaged credit history, but they cost thousands more in interest than standard mortgages.

Subprime lending, by its very nature, places lenders at risk. When all is said and done, that means banks and other players charge higher rates for subprime loans to compensate for potential losses from customers who may run into trouble or default. Subprime loans also cost more because they are considered “nonconforming,” or not up to the standards of Fannie Mae and Freddie Mac. Those two quasi-governmental agencies buy traditional, “conforming” mortgages from lenders, repackage them and sell them to Wall Street investment firms as securities.

Track record counts

Borrowers can fall into the subprime category for any number of reasons, and assessing how risky a customer is can be a difficult thing for lenders. The process relies less on the computerized credit scoring methods widely favored by traditional lenders and more on a borrower’s debt payment track record, according to subprime experts. In the end, customers get stamped with a grade-schoollike ranking: A for those with the best credit, B, C or D for those with progressively worse histories. An E can show up as well but is extremely rare.

One question, two answers

Where someone falls on the scale depends on a number of things. And two lenders may look at the same borrower and arrive at two different credit grades because the categories aren’t set in stone.

Someone with a generally good credit record, but who paid their mortgage 30 days late within the past year, could earn an A-minus. The grade of D could be the result of bankruptcy or foreclosure. Subprime lenders will look at a potential borrower’s general pattern of financial behavior. If you are usually on time with your payments, you’ll most likely be a B or a C consumer.

A borrower’s credit grade determines a number of factors, including what rate the loan will carry and how much of a home’s value will be loaned. On a 30-year fixed mortgage, for instance, a borrower just shy of an A rating would most likely be able to borrow 90 percent of a new home’s value at a rate a couple of percentage points or so above the going rate. Someone with D credit could borrow less at a higher interest rate.

Who is a candidate?

So, if that’s how the subprime process works and those are the rates, who should consider borrowing?

The advice is mixed, but generally speaking, someone whose monthly obligations are swallowing too much of the weekly paycheck might benefit from refinancing the mortgage at a subprime rate and taking out cash in the process to pay off debts. The cost over the loan’s lifetime will rise, but the tax-deductibility of mortgage interest makes it cheaper than the interest charged on most credit cards, auto loans and the like.

And subprime loans can help renters become homeowners. While the rate charged will be high, a one- or two-year history of on-time mortgage payments will help demonstrate creditworthiness. That, in turn, could mean a less expensive refinancing down the road, assuming rates don’t spike.

Still, experts caution that getting a subprime loan means much greater interest costs over time. A 30-year fixed loan for $200,000 at the higher rate of 8.5 percent, for instance, would have monthly payments of $1,538 and total interest of $353,618. Compare that with the 5.51 percent national average (based on a Bankrate.com survey in October 2005), the same loan would require payments of just $1,137 and cost $209,000 in total interest — a savings of $145,000 over the life of the loan.

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