Subprime loans are pricey, but can help credit history

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.