SUBPRIME LOANS: WHAT ARE THEY AND ARE THEY RIGHT FOR YOU?

Subprime loans, those issued to borrowers whose financial and credit situation is “less than prime” are a sub-class of mortgage loans that been available to borrowers over the years. Subprime loans essentially vanished during the mortgage debacle of the last decade but are beginning to make a comeback. And, under the right circumstances, can be a viable option for certain borrowers.

Subprime loans historically are issued to those who have damaged their credit and need a loan that can help finance a home and restore a credit profile. Such loans will have higher rates and a higher down payment compared to other loan programs. The problems with subprime loans began to emerge when certain subprime lenders began altering qualifying guidelines they normally used to rely on. Subprime loans were rarely approved under “stated” or “no documentation” scenarios but as subprime lenders looked to expand their customer base, they slowly began to degrade some very valuable standards. Lenders began to ask for lower down payments. Then they said they didn’t need to verify your income and lowered traditional down payments even further. This led to an historic number of defaults and subprime lenders not only fell out of favor, they very nearly disappeared.

Today however, subprime loans are back on the landscape and are operating under established guidelines that made subprime loans more secure and less risky for lenders to approve. Don’t expect a subprime loan to be a “stated” loan. Subprime lenders will document income as well as assets available to close on a transaction. Subprime borrowers can expect to put at least 20 percent down, or more, and provide full documentation for income and employment. Interest rates for subprime loans are much higher than conventional, that can be expected. And lenders will underwrite a subprime borrower based upon current, verified income and subprime rates. Subprime rates can be as high as 10 percent or more and are also for a relatively short term. So-called “hybrid” loans are common among subprime lenders where the rate is fixed for three or five years and then turns into an annual adjustable rate. So who is a candidate for a subprime loan?

Ideal candidates for a subprime loan are those who have recently experienced some catastrophic event, outside their control, that has ruined their credit. This could be the result of extended unemployment. Or an illness or even a death in the family. A divorce is often the cause of credit problems. A subprime lender will evaluate the circumstances then evaluate the borrowers for the new loan. Once the new loan is approved, the borrowers are on the path to rebuild credit and one of the best ways to improve a credit score is making timely mortgage payments. Once credit scores get back up to a respectable level and now eligible for conventional financing, the subprime loan can be refinanced out of the higher rate into current market rates.

Make no mistake, subprime loans are only for a specific few. Rates are much higher as are down payment requirements. And while those with credit problems can take advantage of a subprime loan have options, a subprime loan is only to be used on a temporary basis. A credit “Band-Aid” as it were. But, when used properly and borrowers are completely aware of what they’re getting into, they can be an option.

For more information or questions about mortgage loan, 
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