The Definition of Subprime Mortgage Loan
- A subprime mortgage is a home loan that is lent to a borrower who has worse-than-normal credit. Because this low credit or lack of credit makes the borrower less trustworthy, the bank charges a higher interest rate. This makes the interest rate worse than the prime rate that banks use as a standard for large loans. Banks typically offer subprime loans only when economic conditions are good and they have confidence in the borrower's ability to repay the loan.
- Credit scores are one of the primary factors in defining a subprime loan. Borrowers with scores less than 660 or so who receive loans tend to receive subprime mortgages. However this is no certain measurement. Some lenders will use the credit score to define subprime mortgages, while others will use other data. Generally, the lower the credit score, the higher the likelihood the loan will be subprime.
- Down payments are an important part of a subprime loan. The down payment is how much money the borrower can immediately pay on the house when the loan is granted. Borrowers who can offer a higher down payment, such as 15 or 20 percent of the property cost, rarely get subprime loans. However, a loan given to a borrower who makes a down payment of 5 percent or less is typically defined as subprime.
- There are other reasons loans are defined as subprime. Sometimes borrowers can have good credit and a sizable down payment, but their financial situation can be uncertain, leading to questions regarding their ability to pay off the loan. If income reports look suspicious or if the borrower has insufficient assets to use as collateral, the loan may be subprime.
- Alt-A loans are a classification of loans between prime and subprime loans, and there is often significant overlap between loans that may qualify as Alt-A loans and those that are subprime.
- ARMs, or adjustable rate mortgages, are very common subprime loans. In these loans, lenders give borrowers a starting low rate, but then raise it. A frequently used ARM is the 2/28 loan: The rate stays low for two years then is raised by the lender by a certain percentage, based on market factors and lender margins. A subprime ARM that starts at 4 percent can jump to 8 percent or higher.