What is a Subprime Mortgage?

Are you familiar with subprime mortgages? If you’re someone with low credit, you definitely need to find out what is a subprime mortgage. It might be a lifesaver for you. Subprime mortgages are home loans designed for borrowers with low credit. They typically carry higher fees and interest rates than the so-called “prime” mortgages available to borrowers with good credit. 

These mortgages are usually available only with adjustable interest rates that can rise and fall over the lifetime of the loan. They may have longer repayment periods than prime mortgages. Continue reading to learn how a subprime mortgage works, when to consider one, and the pros and cons of this type of home loan. 

An Overview of Subprime Mortgage 

Let’s start with the basics: a subprime mortgage is described as a home loan offered to borrowers with poor credit. While the particulars of a subprime borrower vary from one lender to another, subprime mortgages may be available to borrowers with a FICO Score below 670. 

The term “subprime mortgage” fell out of favor following the 2008 financial crisis. That’s why they’re sometimes advertised as “nonprime.” Some subprime mortgages are classified is non-qualified loans (non-QM), indicating lenders must provide strict documentation of a borrowers’ ability to repay the loans. 

How Subprime Mortgages Work 

A subprime mortgage works like a conventional loan, but it has some unique qualities. 

The pricing of subprime mortgages can vary by mortgage type, but all subprime mortgages share these attributes: 

• Higher Interest Charges: Rates on subprime mortgages are generally several percentage points higher than those on conventional mortgages. 

• Higher Closing Costs: Lenders offset some of the risk by collecting high fees upfront. Origination fees may be higher on a subprime loan than on a traditional loan, for instance. 

• Higher Down Payment Requirements: Borrowers with outstanding credit may be able to finance a home by putting down as little as 3% of the purchase price. However, subprime borrowers may be asked to put down 25% or more. 

You can apply for subprime mortgages at banks, credit unions, and online lenders. Subprime borrowers typically undergo a more stringent underwriting process because lenders want to make sure you can repay the loan. 

Types of Subprime Mortgages 

Here are three types of subprime mortgages you may encounter: 

Adjustable-Rate Mortgage (ARM)

 In the beginning, ARM payments are relatively low, for about five, seven, or ten years, based on an introductory interest rate. Then, it adjusts periodically for the remainder of the loan term. 

 ARM interest rates and their monthly payments typically reset every six or twelve months following the initial fixed-rate period, rising or falling in sync with the relevant index the lender uses to determine rates. The maximum annual increase is capped by federal regulation, but shifting payments can jeopardize household budgets. 

 Extended-Term Mortgage

 These loans may come with fixed interest rates, but feature repayment terms of forty or even fifty years, instead of the thirty-year norm for conventional mortgages. Throughout the life of the loan, this can mean hundreds of additional payments. The interest compounds for an extra decade or more, and it has the potential to cost hundreds of thousands of dollars more than a conventional loan. 

 Interest-Only Mortgage

 An interest-only mortgage is similar in structure to an adjustable-rate mortgage. It provides low initial payments by giving you the option to pay only interest due on the loan (without any principal payments) for the first three to ten years of the loan term. At the end of this introductory period, you can renew the loan or refinance, but you must start paying down principal. 

 Interest-only mortgages work best if you make standard interest-plus-principal monthly payments and only resort to lower interest-only payments in cases of emergency, such as times with unexpected expenses. If home prices are dropping in your region, you might even find yourself upside down on the loan and facing a foreclosure or short sale. 

Adjustable-Rate vs. Extended-Term vs. Interest-Only Mortgages 

 Subprime Mortgage vs. Prime Mortgage 

What is a subprime mortgage? You should already have an idea of what it is if you’ve been with us from the beginning. Now, what about prime mortgages? How do the two mortgage options differ? Here are the main dissimilarities between a subprime mortgage and a conventional prime mortgage. 

Credit Score Requirements

Lenders set their own minimum score requirements, but prime loans are generally available to borrowers with FICO scores of 670 or greater, and some lenders require minimum scores as high as 720. 

 Subprime mortgages may be available to borrowers with credit scores as low as 580. 

Down Payment Requirements

 For prime mortgages, lenders routinely accept down payments as low as 10% with a requirement that the buyer pay for mortgage insurance if they put less than 20% down. Borrowers with good credit may be eligible for down payments as low as 3%. 

 By contrast, on subprime mortgages, down payment requirements of 25% or more of the purchase price aren’t uncommon. 

*Score and down payment requirements are subject to lender discretion, so these are general guidelines. 

Advantages and Disadvantages of Subprime Mortgages 

If you’re planning to get a subprime mortgage from a mortgage broker in California, you must weigh the potential benefits and drawbacks of accepting such a loan. 

Pros

• Enabling Homeownership: Subprime mortgages offer a pathway to homeownership when you can’t qualify for a conventional home loan. If you haven’t established a substantial credit history, or if your credit scores are damaged from past mishaps or missteps, a subprime loan may be your only mortgage option. 

• Credit Score Benefits: If you keep up with your mortgage payments and manage other debt wisely, you’ll likely see improvement in your credit scores. Regular on-time mortgage payments will help you build a positive payment history, and payment history is the largest factor influencing your credit score, responsible for up to 35% of your FICO score. 

Cons

• Cost: Charges on subprime mortgages can be significantly higher than those on prime loans, potentially costing you tens or even hundreds of thousands of dollars more than a conventional mortgage on the same property. 

• Budgeting Challenges: The annual rate reset on an ARM and the shift to higher required payments following the intro period on an interest-only mortgage may put stress on many household budgets. If you go either route, plan carefully and do your best to set aside funds to help cushion major payment hikes. 

• Slow Equity Accumulation: Early payments on amortized loans like mortgages are mostly interest, with just a small portion going toward principal. Payments toward the end of the loan term are mostly principal, with just a small share of interest. Home equity – the portion of the home you own – accumulates as you pay down principal. An extended-term loan stretches this process out significantly. 

Equity Accumulation on Extended-Term Loans 

 Should You Get a Subprime Mortgage? 

So, what is a subprime mortgage? It’s a home loan perfect for borrowers with poor credit. The definition of this mortgage differs from one lender to another, but if you have a FICO score below 670, this option might be suitable for you. 

However, you should try to get one only after investigating more conventional mortgage options with several lenders. For example, you can contact a mortgage broker in California at ALT Financial Network, Inc. to find out about the variations in lending standards and what they mean for you. 

Maybe you’ll qualify for a conventional fixed-rate, thirty-year mortgage with us, while another broker offers only subprime loans. In any case, one has to understand the terms of a subprime mortgage before choosing it, including the potential for payment increases. Pay close attention to any prepayment penalties and how much it would cost you if you refinance your loan in the future. 

FAQs 

1. Can a subprime mortgage be refinanced later?

Yes, many borrowers refinance a subprime mortgage after improving their credit. Refinancing can help lower interest rates, reduce monthly payments, or switch to a more stable loan type. 

2. Do subprime mortgages always have adjustable rates?

No, not all subprime mortgages are adjustable. Some offer fixed rates, though they are less common. Terms vary by lender, credit profile, and overall financial stability. 

3. How does income affect approval for a subprime mortgage?

Income plays a major role. Lenders review steady earnings, employment history, and debt levels to confirm repayment ability, even when credit scores fall below prime lending standards. 

4. Are subprime mortgages harder to qualify for than prime loans?

Subprime mortgages often require more documentation and higher down payments. While credit standards are lower, lenders apply stricter checks to manage higher lending risk. 

5. Can subprime borrowers pay off their loan early?

Some subprime mortgages allow early payoff, but others include prepayment penalties. Always review loan terms carefully to understand potential costs before paying off or refinancing early.