Question:

What is the definition of a subprime mortgage?

Answer:

A subprime mortgage, as the name implies, is a non-prime mortgage. Unlike prime mortgages, subprime mortgages usually have high interest rates and nonconforming structures. They are meant for high-risk borrowers.

The Subprime Mortgage for a High-Risk Borrower

High-risk mortgage applicants are borrowers who are much more likely to miss mortgage payments, pay monthly dues late and default on their mortgage. They usually have one or more of the following characteristics:

  • They have a low FICO score.

    There is no universal FICO score cut-off for subprime borrowers. Some mortgage lenders consider anyone with a FICO score below 660 to be high-risk. Some, on the other hand, have a lower cut-off (e.g. 620).

  • They have a history of payment delinquencies.

    Mortgage applicants whose credit records show they've been missing payments on their credit cards and other loans are high-risk borrowers. Late payments (more than 30 days) are also used as an indicator of the borrower's likelihood of default.

  • They have a heavy debt burden.

    Mortgage applicants have a heavy debt burden if a large portion of their monthly income goes to paying/servicing credit card and personal debts.

  • They have a record of a bankruptcy or foreclosure.

Benefits of a Subprime Mortgage

Subprime mortgages make home purchase a viable option for more people. Specifically, they meet the need of high-risk and poor-credit borrowers for mortgage options.

Subprime borrowers do not pass the criteria set by Fannie Mae and Freddie Mac. Thus, they cannot borrow money through conventional mortgages. Through a subprime mortgage, someone who has no credit history or has poor credit gains an alternative and gets a chance to buy a home.

The subprime mortgage fueled the growth of the mortgage market. The fact that more borrowers were in the market to buy homes also led to a boom in the housing sector.

Drawbacks of a Subprime Mortgage

A subprime mortgage usually comes with very high interest rates. Since subprime borrowers are much more likely to default than other types of borrowers, mortgage lenders tag on these high interest rates to compensate for the risk they're taking on. Unfortunately, the high interest rates also mean a high-risk borrower becomes even more likely to default on his loan.

There is also no clear definition for a subprime mortgage. As such, unscrupulous lenders were able to deceive good-credit borrowers into signing up for subprime mortgages. The subprime mortgages' high interest rates and penalties soon took their toll. More and more good-credit borrowers defaulted. This eventually led to the subprime mortgage market crash and the subsequent home mortgage foreclosure crisis.

Mortgage rates hit their lowest since 1955. Ask the home loan experts we recommend Quicken Loans how to take advantage of them.
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