What Is a Subprime Mortgage?
Subprime mortgages are a necessary part of the housing industry. A subprime mortgage is more expensive than a prime mortgage, but allows individuals to become homeowners who otherwise would not have that option. Subprime mortgages can be dangerous if you do not carefully evaluate your loan terms to avoid falling victim to predatory lending practices.
The Facts
A subprime mortgage is a mortgage loan geared primarily toward borrowers with lower credit scores and a damaged credit history. These borrowers do not qualify for standard mortgage loans due to the high risk of default that they present. Subprime loans carry higher interest rates and fees than loans offered to prime borrowers. Loans that fall into this category are also more likely to include monthly payments that increase over time, rather than remaining stable for the life of the loan.
History
Subprime mortgages hit their peak during the U.S. housing boom in 2006. By that time, subprime mortgages accounted for 14 percent of all mortgage loans distributed that year--up from a mere 9 percent in 2001. (See Reference 1) The popularity of the subprime market drove many lenders to provide borrowers with "creative" funding. Subprime lenders wrote loans to borrowers with no proof of income, loans that charged no interest for a set period of time or loans that offered low interest rates for several years before adjusting to a much higher rate later on. Because those who sought a loan through the subprime market were at a greater risk of default, these creative funding techniques were the precursor for a surge in foreclosures as more and more subprime borrowers could not keep up with monthly mortgage payments due to adjusting interest rates.
Effects
During the course of the housing boom, purchasing a home was relatively easy. The lowest rates came with adjustable rate mortgages. After several years, the rates on adjustable rate mortgages began to increase dramatically. Some families saw mortgage payments skyrocket to more than double their original payment. Unable to pay the new rates, borrowers began to lose their homes to foreclosure. The more foreclosures that occurred, the more lenders were wary of lending. This made getting a home after early 2008 difficult for those restricted to shopping in the subprime market only. The subprime mortgage market is often blamed for contributing to substandard economic conditions in the U.S. after the "burst" of the housing bubble in 2006.
Predatory Lending
Predatory lending is a practice used by some unscrupulous lenders to take advantage of subprime borrowers. The practice encompasses any behavior that is only in the financial interests of the lender and not the borrower. Predatory lending tactics are also commonly veiled over when described to the consumer, or even included in the mortgage contract but never mentioned. Some examples of predatory lending practices are convincing homeowners to refinance when they do not need to, lying on loan paperwork and levying abnormally large prepayment penalties to prevent refinancing. (See Reference 3)
Misconceptions
You may naturally assume that every borrower with a subprime mortgage has low credit and was not able to make a substantial down payment, but that is not always the case. Many borrowers who are eligible for prime loans are steered into subprime loans by lenders who solicit them and never mention their eligibility for better rates and loan terms. Do not assume that you are only eligible for a subprime mortgage loan just because that is what your lender tells you. Shopping around for loan terms and rates is a good practice to ensure that no lender can trap you into a dishonest loan.
