Things to know about a subprime loan
By Melissa
Wirkus
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.