What Is a Subprime Mortgage and How Does It Differ From Conventional Lending Standards?
We are reader-supported. When you buy through links on our site, we may earn an affiliate commission.
TL;DR: What is a subprime mortgage? This is a home loan for borrowers with low credit scores, which lenders consider high risk. It has higher interest rates and fees than a conventional mortgage, making it a more expensive path to homeownership.
You might be concerned that homeownership is a pipe dream instead of one that can come true if you have a low credit score. However, that’s not necessarily the case. Understanding mortgages in all their forms is crucial when house-hunting, and a subprime mortgage is a great option for those who don’t qualify for traditional loans.
Although subprime lending has a negative reputation, understanding it is the first step toward financial empowerment and sets you on the path to homeownership.
What Is a Subprime Mortgage?
A subprime mortgage is a loan offered to people who do not qualify for conventional mortgages due to a low credit score or other negative factors in their financial history. They have higher interest rates, which can increase significantly over time, to protect the lender from the greater risk they incur.
- Subprime mortgages are designed for borrowers with credit scores of 620 and under.
- They have higher interest rates than prime mortgages, and adjustable-rate loans will increase over time.
- They often come with higher fees and stricter terms.
- They are considered a higher risk for lenders.
Who Typically Needs a Subprime Mortgage?
Subprime lending is there for people with credit challenges who want to buy a house. They may have a history of late payments or defaults, a high debt-to-income ratio or a recent bankruptcy. You may be struggling to rebuild your credit or live in a low-income neighborhood. You might need to purchase a home quickly and can’t wait to improve your credit score. This option is typically seen as a temporary solution or a last resort for those in challenging financial situations.
What Are the Risks and Rewards of Subprime Lending?
A subprime mortgage carries both positives and negatives, and it’s vital to consider both before applying.
The Primary Reward: Homeownership
A subprime loan makes homeownership possible for people who would otherwise be locked out of the market. You get the sense of pride that comes with attaining this major life goal. Plus, you get to build equity, which improves your financial situation.
Understanding the Risks
There are several downsides to consider when applying for a subprime mortgage. These include:
- Higher costs: The higher interest rates mean you’ll be paying significantly more money over the life of the loan.
- Adjustable rates: Adjustable-rate mortgages may draw you in with an initial low rate that can balloon into unaffordable payments.
- Prepayment penalties: You might think paying off your mortgage early is a good idea, but some lenders will charge penalties for doing so.
- Foreclosure risk: The higher costs can place you at a greater risk of default and foreclosure.
How Do You Move on From a Subprime Mortgage?
Obtaining a subprime mortgage enables you to buy a house, but you should not look at this as a permanent situation. It is possible to get out from under and obtain a better rate down the road. View it as a stepping stone that sets you on the path to financial recovery. Consider these ways to improve your circumstances and strengthen your monetary skills.
Improve Your Credit Score
Focus on raising your credit score. You can get a copy of your credit reports for free from the three major credit-reporting agencies — Experian, Equifax and TransUnion —once a year to see where you stand. Be sure to pay all bills on time, pay down your credit card balances and avoid opening new lines of credit. Avoid closing paid-off accounts, which can actually damage your score.
Explore Refinancing Options
Once your credit score and financial situation improve, you can refinance your mortgage into a conventional loan with better terms. You can seek lower interest rates and a reduced monthly payment. Rest assured: This doesn’t mean you must get another 30-year term. You can negotiate a custom repayment period based on how much time you have left on your current loan.
Consider Government-Backed Loan Programs
There are other refinancing options if you are unable to go the conventional route. The Federal Housing Association, Department of Veterans Affairs and Department of Agriculture are additional refinancing avenues to take. They sometimes have more flexible credit requirements if needed.
Frequently Asked Questions About Subprime Mortgages
Here are some common questions you may have about taking out a subprime loan.
What is subprime lending?
Subprime lending is another term for a subprime mortgage. It refers to any loan given to borrowers with poor credit histories and lower credit scores.
What credit score is considered subprime?
Generally, subprime credit scores are below 620, although this amount can vary by lender. Be sure to check before applying for a mortgage.
Are subprime mortgages illegal?
These mortgage options are not illegal. However, they are more heavily regulated due to the 2008 financial crisis, which became known as the Great Recession. Home prices dropped as a result of a rapid increase in the number of subprime mortgages that were defaulted on, which led to a housing bubble. Regulations are now in place to protect consumers from unscrupulous lenders.
What is the difference between a prime and a subprime mortgage?
The primary difference is the borrower’s credit risk based on credit and financial history. This dictates the loan’s interest rate and terms.
Can you refinance a subprime mortgage?
Refinancing is a common goal for subprime borrowers once their credit and financial standing improve. Several options are available if you are interested in pursuing this path, including conventional and government-backed loans.
Make a Subprime Mortgage Work for You
A subprime mortgage has its advantages and disadvantages. It helps you achieve the dream of homeownership, although this comes at a cost. The goal should be to improve your financial health so you can transition to a more conventional loan with a lower interest rate and better terms.
The road to homeownership is not easy for everyone. However, with a bit of work and dedication, you can achieve your dream to live on better terms by taking control of your financial future.
About The Author
Peter is an associate editor for Renovated with over 5 years of experience writing in the home improvement and real estate sectors. He grew up learning woodworking and DIY skills from his grandfather, giving him a unique perspective on home renovation and maintenance. His personal interest in business has also led to him becoming a well-informed voice in the real estate world. He specializes in offering insightful, practical advice to new homeowners, guiding them on how to maximize their ROI.
When Peter has downtime, you'll find him at the top of a mountain, enjoying a scenic view. He also spends a lot of time cultivating his vegetable garden and tinkering in his woodshop.
