Things to know about a subprime loan
A subprime loan is a mortgage offered to people with a blemished credit history or sketchy financial past. There are various benefits and drawbacks to taking out a subprime loan, and they can be viewed as a bit riskier than other traditional loans.
Qualifying for a mortgage depends on a variety of factors, one of them being your credit score. Without a good credit score, meaning around 700, you will probably not qualify for a regular mortgage and will have to take out a subprime loan.
Although subprime loans allow people to get into homes that they normally probably couldn’t, they also carry higher interest rates and monthly payments because of the increased risk of the borrower.
Before you take out a subprime loan, there are various things you should know about this mortgage product.
“Experts caution people to carefully weigh the benefits and drawbacks of taking out a subprime loan. Having one and handling it well can help repair a damaged credit history, but a subprime loan can cost thousands more in interest than standard mortgages.”
“Subprime lending, by its very nature, places lenders at risk. When all is said and done, that means banks and other players charge higher rates for subprime loans to compensate for potential losses from customers who may run into trouble or default. Subprime loans also cost more because they are considered ‘nonconforming,’ or not up to the standards of Fannie Mae and Freddie Mac.”
There are various reasons why a borrower would fall into the subprime category, and a lender has to assess the risk of each potential borrower.
In addition to looking at the credit score, lenders also give every subprime borrower a letter grade that assesses their repayment history and risk, ranging from the letters A through D. An E can show up for the worst credit out there, but that is extremely rare.
This credit grade determines a variety of different things about a subprime loan.
“A borrower's credit grade determines a number of factors, including what rate the loan will carry and how much of a home's value will be loaned. On a 30-year fixed mortgage, for instance, a borrower just shy of an A rating would most likely be able to borrow 90 percent of a new home's value at a rate a couple of percentage points or so above the going rate. Someone with D credit could borrow less at a higher interest rate.”
Subprime loans can help people get into homes like no other mortgage product on the market can.
But they still run the risk of being way too expensive over time for some people.
“Still, experts caution that getting a subprime loan means much greater interest costs over time. A 30-year fixed loan for $200,000 at the higher rate of 8.5 percent, for instance, would have monthly payments of $1,538 and total interest of $353,618. Compare that with the 6.71 percent national average (based on a Bankrate.com survey in June 2006), the same loan would require payments of just $1,292 and cost $265,078 in total interest -- a savings of nearly $90,000 over the life of the loan.”
Although you may not have a choice when taking out a subprime loan, you should carefully weigh the benefits and drawbacks prior to the application process. Always talk to a trained professional before making any major decisions.
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