Avoiding Subprime Mortgages

Sep 18th, 2007 @ 7:06 PM by MortgageMentor

The Federal Reserve has been making attempts to inject liquidity into our stalled-out housing market. However that doesn’t really address an underlying problem–the subprime loans. Now that we’ve had our little scare involving subprime lending, a lot of people are wondering exactly what it is all about.

A subprime lender is a lender who will loan money to borrowers who wouldn’t otherwise qualify for a housing loan. You might be surprised to learn that the subprime lenders are often branches of the ”regular” lending institutions—they just operate under a different name. Subprime lending account for $600 billion in loans last year.

You won’t see the title “subprime” on their banners; the subprime lenders do not normally identify themselves. But you can tell if you study the prices offered; subprime lending costs more than mainstream. They reel you in by offering really low interest rates for the first few years—but in most cases you aren’t building equity because of the artificially low payments. So borrowers are not able to refinance when the payment begins to skyrocket.

Lenders May Offer Both

If your lender has found that you cannot qualify for conventional financing, and then he drops you to a subprime loan, you are dealing with a lender who offers both types of financing. One of the interesting things that has happened with the development of the subprime market is that many borrowers who could have qualified for mainstream lending have ended up with subprime loans—and the high prices that go along with them. This is often due to the marketing pitch they hear from the lender, and the fact that they didn’t shop around to other lenders.

Why didn’t you qualify?

Often the low credit score is the cause for not qualifying, which usually means a FICO score between 300 and 620. Sometimes a mid-range score will disqualify you, if your debt-to-income ratio is close or your documentation of assets and income is weak.

How low can you go?

Subprime lending is based on the same factors as prime lending. That means that the rate is higher if you have a small down payment or if your credit score is low. But a lot of subprime loans go into default, so the lending costs are higher to cover their risk. Costs are also high because a lot of the applications end up being rejected.

In addition to the loan not allowing the borrower to build equity, there are usually stiff prepayment penalties. So even if the borrower does manage to get a refinance, he or she will pay—dearly.

To keep from ending up in the subprime market

• · Always check your eligibility with several lenders; often requirements will vary
• · Don’t sign anything without reading and understanding the loan terms and obligations
• · Insist that your lender disclose all third party fees, lock requirements, and other information that you need to make an educated decision.
• · If you are getting an Adjustable Rate Mortgage, ask for schedules of the monthly payment and interest rates under the worst case assumption in writing.