Subprime lending:

Borrowers who have horrible credit. They can live in huge houses or little houses (or condos, etc.). The lenders like to make these loans because they can charge high fees and thereby make more money. The borrowers are sitting ducks for the rip-off artists in the mortgage business. Frankly, most of these borrowers don’t care if they end up in foreclosures and also the lenders love to make bunches of money charging high fees on just about every line of the closing statement. These borrowers tell friends they own a home. They do not own a home because they have not paid for it. The lender owns the home. Only when these people have paid for the home do they own it. Look at your closing statement and then ask the lender what car they drive: a Lexus at $50,000?

Definition of subprime lending:

While there is no official credit profile that describes a subprime borrower, most have a credit score below 660.

Subprime lending, also called "B-Paper," "near-prime," or "second chance" lending, is a general term that refers to the practice of making loans borrowers who do not qualify for market interest rates because of problems with their credit history. A subprime loan is one that is offered at a rate well above the prime rate, which is a benchmark that banks set for establishing interest rates for other loans.

Subprime lending encompasses a variety of credit instruments, including subprime mortgages, subprime car loans, and subprime credit cards, among others.

Subprime lending is typically defined by the status of borrowers. A subprime loan is, by definition, a loan made to someone who could not qualify for a more favorable rate. Subprime borrowers typically have low credit scores and histories of payment delinquencies, charge-offs, or bankruptcies. Because subprime borrowers are considered at higher risk to default, subprime loans typically have less favorable terms than their traditional counterparts. These terms may include higher interest rates, regular fees, or an up-front charge.

Proponents of the subprime lending in the United States have championed the role it plays in extending credit to consumers who would otherwise not have access to the credit market. But opponents have criticized the subprime lending industry for practices such as targeting borrowers who did not have the resources to meet the terms of their loans over the long term. These criticisms have increased since 2006 in response to the growing problems in the U.S. subprime mortgage industry, wherein hundreds of thousands of borrowers have been forced to default, and several major subprime lenders have filed for bankruptcy.

Subprime lenders.

To access this increasing market, lenders take on the risks associated with lending to people with poor credit ratings. Subprime loans are considered to carry greater risk for the lender due to earlier mentioned credit risk characteristics of the typical Subprime borrower. Lenders use a variety of methods to offset these risks. In the case of many Subprime loans, this risk is offset with a higher interest rates.

Subprime borrowers

Subprime offers the opportunity for borrowers with less than ideal credit to gain access to credit. Borrowers use this credit to purchase homes, or in the case of a cash out refinance, finance other forms of spending such as purchasing a car, paying for living expenses, remodeling a home, or even paying down a high interest credit card. However, due to the risk profile of the subprime borrower, this access to credit comes at the price of higher interest rates.

Generally, subprime borrowers will display a range of credit risk characteristics that may include one or more of the following:

Two or more loan payment paid past 30 days due in the last 12 months, or one or more loan payments paid past 60 days due the last 24 months;

Judgment, foreclosure, repossession, or non-payment of a loan in the prior 24 months;
Bankruptcy in the last 5 years;

Relatively high default probability as evidenced by, for example, a credit bureau risk score (FICO) of 660 or below (depending on the product/collateral), or other bureau or proprietary scores with an equivalent default probability likelihood.

Types of subprime lending

Subprime mortgages

Subprime mortgage loans are riskier loans in that they are made to borrowers unable to qualify under traditional, more stringent criteria due to a limited or blemished credit history. Subprime borrowers are generally defined as individuals with limited income or having FICO credit scores below 620 on a scale that ranges from 300 to 850. Subprime mortgage loans have a much higher rate of default than prime mortgage loans and are priced based on the risk assumed by the lender.

Although most home loans do not fall into this category, subprime mortgages proliferated in the early part of the 21st Century. About 21 percent of all mortgage originations from 2004 through 2006 were subprime, up from 9 percent from 1996 through 2004. Subprime mortgages totaled $600 billion in 2006, accounting for about one-fifth of the U.S. home loan market.

There are many different kinds of subprime mortgages, including:

Interest-only mortgages, which allow borrowers to pay only interest for a period of time (typically 5-10 years);

“Pick a payment” loans, for which borrowers choose their monthly payment (full payment, interest only, or a minimum payment which may be lower than the payment required to reduce the balance of the loan); and

Initial fixed rate mortgages that quickly convert to variable rates.

This last class of mortgages has grown particularly popular among subprime lenders since the 1990s. Common lending vehicles within this group include the "2-28" loan, which offers a low initial interest rate that stays fixed for two years after which the loan resets to a higher adjustable rate for the remaining life of the loan, in this case 28 years. The new interest rate is typically set at some margin over an index, for example, 5% over 12-months . Variations on the "2-28" loan concept include the "3-27" and the "5-25".

History

Subprime lending evolved with the realization of a demand in the marketplace and businesses providing a supply to meet it. With bankruptcies and consumer proposals being widely accessible, a constantly fluctuating economic environment, and consumer debt load on the rise, traditional lenders are more cautious and have been turning away a record number of potential customers. Statistically, approximately 25% of the population falls into this category 620).

As with subprime lending in general, subprime mortgages are often defined by the type of consumer to which they are made available. According U.S. Department of Treasury guidelines issued in 2001, "Subprime borrowers typically have weakened credit histories that include payment delinquencies, and possibly more severe problems such as charge-offs, judgments, and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios, or other criteria that may encompass borrowers with incomplete credit histories."

Beginning in late 2006, the U.S. subprime mortgage industry entered what many observers have begun to refer to as a meltdown. A steep rise in the rate of subprime mortgage foreclosures has caused more than two dozen subprime mortgage lenders to fail or file for bankruptcy. The failure of these companies has caused stock prices in the $6.5 trillion mortgage bundled securities market to collapse, threatening broader impacts on the U.S. housing market and economy as a whole. The crisis is ongoing and has received considerable attention from the U.S. media and from lawmakers in the early part of 2007.

Observers of the meltdown have cast blame widely. Some have highlighted the predatory lending practices of subprime lenders and the lack of effective government oversight. Others have charged mortgage brokers with steering lenders to unaffordable loans, appraisers with inflating housing values, and Wall Street investors with backing subprime mortgage securities without verifying the strength of the underlying loans. Borrowers have also been criticized for entering into loan agreements they could not meet. Many accounts of the crisis also highlight the role of falling home prices since 2005. As housing prices rose from 2000 to 2005, borrowers having difficulty meeting their payments were still building equity, thus making it easier for them to refinance or sell their homes. But as home prices have weakened in many parts of the country, these strategies have become less available to subprime borrowers.

Several industry experts have suggested that the crisis may soon worsen.

Subprime defined
Generally, subprime mortgages are for borrowers with credit scores under 620. Credit scores range from about 300 to about 900, with most consumers landing in the 600s and 700s. Someone who is habitually late in paying bills, and especially someone who falls behind on debts by 30 or 60 or 90 days or more, will suffer from a plummeting credit score. If it falls below 620, that consumer is in subprime territory.

Few lenders will use the term "subprime" to describe you or your loan, because it's considered bad salesmanship. You might hear the word "non-prime" or, more likely, an adjective won't be used to describe the mortgage at all.

Mortgages for people with excellent credit are somewhat of a commodity, with rates that don't vary much from lender to lender for equivalent loans. That's not the case with subprime mortgages. You might receive widely differing offers from different subprime lenders because they have different ways of weighing the risk of giving you a loan. For that reason, it's important to comparison-shop when your credit score is less than 620.

How subprime mortgages differ
Subprime loans have higher rates than equivalent prime loans. Lenders consider many factors in a process called "risk-based pricing" when they come up with mortgage rates and terms. This makes it impossible to generalize about subprime rates. They are higher, but how much higher depends on factors such as credit score, size of down payment, and what types of delinquencies the borrower has in the recent past (from a mortgage lender's standpoint, late mortgage or rent payments are worse than late credit card payments).

A subprime loan also is more likely to have a prepayment penalty, a balloon payment, or both. A prepayment penalty is a fee assessed against the borrower for paying off the loan early -- either because the borrower sells the house or refinances the high-rate loan. A mortgage with a balloon payment requires the borrower to pay off the entire outstanding amount in a lump sum after a certain period has passed, often five years. If the borrower can't pay the entire amount when the balloon payment is due, he/she has to refinance the loan or sell the house.

Researchers contend that prepayment penalties and balloon payments are associated with higher foreclosure rates. The subprime mortgage industry contends that borrowers get lower interest rates in exchange for prepayment penalties and balloon payments, but that point is debatable.

Predatory loans
Subprime customers have to be on the lookout for predatory lenders who set out to cheat borrowers. There are several predatory tactics, and sometimes a lender will combine them. Some lenders soak naive borrowers with outrageous fees and sky-high interest rates. These lenders are likely to tell the borrower that his/her credit score is lower than it really is.

Another predatory tactic is to pressure a homeowner to refinance the mortgage frequently, charging high closing fees each time and rolling the closing costs into the mortgage amount. That goes hand-in -hand with another predatory tactic: Issuing a loan regardless of the borrower's ability to repay it. When the borrower inevitably defaults, the predatory lender forecloses and sells the property.

An ethical mortgage lender doesn't want to foreclose on a property because foreclosure is a money-losing process. An ethical lender makes money by charging interest and loses money by foreclosing. A predatory lender, on the other hand, profits by repeatedly collecting closing fees, then seizing the house.

To defend yourself from predatory lenders, find your credit score before shopping for a mortgage, and ask people whom you trust for referrals to mortgage lenders. And comparison-shop by going to at least two mortgage brokers or lenders.

Arrows Real Estate!

Subprime lending:

Definition of subprime lending:

Subprime lenders.

Subprime borrowers

Subprime mortgages