Anyone who has kept up with financial news has read a lot about subprime loans. The abundance of subprime mortgages helped destabilize the housing market and let to its collapse, and a lot of foreclosures. Now these loans are making a comeback, calling themselves “nonprime” loans or mortgages.
What is the difference between nonprime and subprime loans? And while we are at it, what exactly is a subprime loan to begin with? Are they bad for the lender or the borrower, or are they bad for everyone?
The “prime” in subprime loans refers to the borrowers, not the interest rates being charged. A prime candidate for a mortgage will have a very good credit score, little debt, a good history of repayment, and a good, steady income.
A subprime loan candidate will have a bad credit score (traditionally meaning a FICO score lower than 640, but that ebbs and flows). They may have some black marks on their financial records, like divorce, unemployment, and college or medical debt.
A subprime loan is a risky loan. Subprime borrowers have records that show they may not be able to repay the money they borrow. And while taking a risk once and a while can pay off, the more subprime loans that are issued can destabilize the entire market – which in general needs its loans to be repaid.
The Benefits of Subprime Loans
The benefit for borrowers can be great. A subprime loan is essentially a loan made to someone who shouldn’t be able to get a loan. This means that a great many industrious, hard working people with poor credit now have a chance to secure a mortgage and buy the home they want.
But what is the reward for the lender? If subprime loans are such a great risk, that means the reward should be just as great.
In the business of big banking, owning debt is almost as good as owning money. Mortgages are bound together into securities, which are valuable commodities in the financial market. Securities can be bought, sold, and traded.
This is why so many questionable loans have been made in the past – when there is sufficient volume of debt, there are more and more mortgage-backed securities to be had. The abundance of securities that were backed by bad (defaulting) loans is what made the bursting of the housing bubble in 2007. At the time there were over $1.3 trillion in subprime mortgages, a risk the industry couldn’t sustain.
Making a Comeback
Since the bubble burst, subprime loans have plummeted down to a much more manageable level. In 2013 there were $3 billion worth of subprime loans originated, compared with the $625 made in 2005. By comparison, this is just a drop in the bucket. And thus, some lenders are seeing the market as wide open to start higher levels of subprime lending once more.
Because of the stigma attached to subprime loans (they were key in the housing crisis, and most people view them negatively even they don’t know exactly subprime loans are), some lenders are simply changing the name.
Other descriptions for subprime loans are nonprime loans, nearprime loans, and second chance loans. They have also been called NINA loans, for No Income, No Assets, and even referred to as Liar Loans, because the income information provided wasn’t verified, and in some cases assumed to be false yet the loan was approved anyway.
Subprime loans can work for people who wouldn’t ordinarily qualify for a home loan, but there is a catch. There is always a catch.
In some cases, a very high deposit is required, as much as 30%, to secure the loan. In other cases the loans are “adjustable rate” which means the interest rate can change greatly over time. Adjustable rate loans are usually set up to allow the borrower a very modest monthly payment at first, to help convince the borrower they can afford the payments. But within years the APR can skyrocket, leaving the borrower on the hook for payments they could never afford.
That isn’t to say that a new resurgence of subprime loans is on the way – perhaps the lending system has learned its lesson. Investors remain weary of new securities backed by subprime loans. But they are out there. For those of you with a less than perfect credit score, looking for a bad credit loan, there is hope for you still.
But please, read the fine print, trust your lender, and find out what all the details of the mortgage are – make sure the loan is right for you, and not too good to be true.