What is a subprime mortgage?
A subprime mortgage is a home loan offered to customers with poor credit history. These loans carry higher interest rates, justified by the greater risks associated with buyers that have poor credit.
Signing on for a subprime mortgage likely will mean that you are locked into an adjustable-rate mortgage rather than a fixed-rate mortgage. Unless you are certain that your income is going to increase each year, it’s difficult to budget for a mortgage that may rise with each adjustment.
Lending money to high-risk borrowers at a premium interest rate is nothing new. Loan sharks have been doing it since man began to borrow money. The temptation to take advantage of borrowers is especially keen during times of economic hardship.
According to the Consumer Financial Protection Bureau (CFPB), lenders and brokers are not obligated to offer you their best deal. If a lender tells you that you do not qualify for anything other than a high-interest, subprime mortgage, it’s not necessarily the truth.
It’s possible that you qualify for a prime mortgage with another lender or qualify for a Federal Housing Administration loan. One lender’s assessment of your situation is just that — one lender’s assessment. You should check with a number of mortgage lenders before settling on a particular loan.
While subprime loans were not the sole reason for the housing meltdown of 2007, it did play a role. Also at play were buyers who purchased real estate under the misguided belief that it would never decrease in value.
The mortgage landscape has changed since the mortgage crisis. Since 2009, the government has created regulations, making it more difficult for banks to approve bad loans.
Still, subprime mortgages exist. Now they are marketed to buyers who would not have had a problem taking out a prime mortgage before the housing bubble burst. Borrowers seeking the most favorable interest rate on a prime mortgage in 2017 need a credit score of around 720 and a debt-to-income ratio in the neighborhood of 36 percent.
Subprime mortgage example
It’s natural to get excited about buying your own home, excited enough to take out a risky mortgage. Here are four examples or why you should avoid a subprime mortgage:
Higher costs: Lenders charge more interest on a subprime loan.
Unpredictability: If you’re someone who wants to plan for the financial future, it’s tough to never know precisely what your mortgage will be after an adjustment to an adjustable-rate mortgage.
Higher default rates: Buyers with subprime loans tend to have higher mortgage default rates.
Less access to credit: A higher mortgage payment increases your debt-to-income ratio, making it more difficult to qualify for other types of loans when you need them.