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What is a Subprime Loan?

By Arvin Sahakian · Jun 15, 2015 · Mortgage

What is a Subprime Loan?

Image courtesy of Flickr, James Theophane

Subprime mortgages are ideal for borrowers with less than stellar credit. They offer competitive rates and the ability to finance property using traditional methods and lenders.

Serious credit problems, such as a recent foreclosure or a bankruptcy, may prevent you from qualifying for any type of mortgage. However, lesser credit flaws such as collection accounts or lower than average credit scores can make it more difficult to find a mortgage loan, but not impossible.

This is where subprime mortgages and lenders come into the picture. It is important to understand exactly what one of these loans entail before you fill out a loan application seeking an approval.

What is a Subprime Mortgage?

A subprime mortgage is not unlike a typical mortgage loan, but is intended for borrowers with lower credit ratings. Conventional mortgages are not available to these borrowers due to lenders having a view that such borrowers are a riskier investment than borrowers with better credit history.

Lenders charge higher interest rates for a subprime mortgage to compensate for the increased risk, however many lenders offer rates that are very competitive to conventional mortgages.

Credit Requirements

Subprime mortgages are more forgiving of credit flaws. As such, a borrower who may not qualify for a conventional loan will have a better chance of qualifying for a subprime mortgage.

It's important to remember that each lender has their own requirements. You should expect to have a 5% - 20% down payment on a purchase loan with verifiable income. A subprime mortgage for a refinance will require you to have equity in your home, anywhere from 3.5% - 20% of the property value, depending on credit circumstances and the type of loan program.

Although it is possible to get a loan with a lesser credit score, 620 is typically the "cutoff" point before it becomes more difficult to qualify for a subprime mortgage. Borrowers unable to attain a subprime loan due to an extraordinary low credit ratings are left with very few options, such as a hard money loan. A hard money loan focuses more on the value and equity in your home, as opposed to your credit score and history.

Document Requirements

There are documentation requirements in place that will be collected and reviewed by the underwriter-mainly to assure that the buyer will have the ability to repay the loan if you qualify. Here is a list of some of the required documents:

  • 2 Years of Tax Returns
  • W2 and/or 1099 Forms
  • Most Recent Paystubs (from last 30 days)
  • Bank Statements (3 - 6 months' worth)

Disadvantages of Subprime Mortgages

While they make it easier for those with less than stellar credit qualify for home loans, it is vital that you consider all of the disadvantages before committing to a subprime mortgage. Some of the most significant of these disadvantages include:

Disadvantage Description
Higher Cost The cost to close on a subprime mortgage is generally higher than a standard loan. While this may be able to roll into the mortgage, it can be a serious consideration for cash-strapped homebuyers.
Higher Rate The interest rate of a subprime mortgage is nearly always going to be higher than on a conventional loan. The reason for this is the risk the lender is taking by working with a buyer who has less-than-stellar credit.
Limitations Many lenders are more particular about the houses they will lend for on a subprime mortgage. It may be that this is not the right type of loan for a "fixer upper" or an investment property, so keep this in mind when shopping.

Advantages of Subprime Mortgages

Clearly, there are advantages to subprime mortgages. Consider the following:

  • Those who cannot qualify for a conventional mortgage can apply to qualify for a subprime mortgage. This can allow people to get out of the renting cycle and into a home of their own.
  • You will have the ability to consolidate loans. If you have credit card or other debt, you may qualify for a higher loan amount in a subprime mortgage-allowing you to consolidate your bills for easier repayment and a lower overall monthly payment.

Ideal for Below Average Credit

While a subprime mortgage is not the right solution for every buyer, it can be the ideal way for those who have below average credit to pull themselves out of a bad situation by consolidating debts into a mortgage through a refinance or become a new homeowner.

The most important thing to remember is that you are in the driver's seat. Do your research and compare rates from a number of lenders to find the ideal loan for your particular borrowing needs.

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