What is Subprime Lending?

Generally speaking, subprime loans are loans that carry a higher interest rate than a prime rate loan. The ideal prospect for a subprime loan is a person with a poor or limited credit history. The higher interest rate is to compensate the lender for the increased credit risk.

Very few lenders advertise themselves as a sub-prime lender. The definitive way to tell a subprime lender is with the rates that are charged. Do I need to say, if you can qualify for a prime rate loan, avoid subprime lenders.

A subprime borrower is one who would fail to qualify for a prime loan generally due to a low credit score. That score is normally referred to as a FICO Score. The score in the mid range could qualify a borrower for a loan but additional factors are taken into account. Those factors could include the down payment proposed, your amount of debt, and your ability to document your income.

Borrowers that are self-employed often cannot document their income and apply for stated income loans. A stated income loan is simply the income the borrower states on the application form. Because the income cannot be verified, the interest is higher than normal but the loan can still be given.

Subprime lenders use the same factors as prime lenders to determine an interest rate. Rates are higher with a low credit score and if the down payment is minimal. Still, keep in mind the rates and fees are higher at subprime lenders due to the higher risk and higher costs. Additionally, more subprime loans go into default then prime loans.

When Prime Borrowers Go Subprime

It amazes me when I see a prime borrower end up with a sub-prime loan. They have the credit score, the down payment and the documented income but they pay sub-prime prices.

The main reason for this is that prime borrowers are constantly being bombarded by subprime lenders on radio and TV with “Unbelievable Deals” to finance or re-finance a mortgage. They pitch the cash that you can clear on the deal or the lower interest rates that lower the monthly payment. They forget to mention in the advertisement that that teaser interest rate will expire and your house payment might double.

If you’re in the market to finance or re-finance a home, please check around before deciding on a loan. TV is great for mindless entertainment but use your mind when it connects to your wallet. Check with mainstream lenders to determine your eligibility for a prime loan.

In 2006, the Wall Street Journal reported a surprising fact that 61% of all borrowers that secured subprime loans had a credit score that would have qualified them for a prime loan. Need I say more?

Subprime exist to allow access to the market of no-credit or poor-credit borrowers. These are also the higher risk borrowers. You pay more, which is no big surprise. They lose more, also no big surprise. They have an endless supply of prospects, unfortunately, no big surprise.