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If you’re not in a rush for housing, it’s probably better to improve your credit instead of getting a subprime loan.
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Borrowers may be offered a subprime mortgage if their FICO credit score falls below 670.
Subprime mortgages come with higher interest rates and fees, reflecting greater risk to lenders.
Alternatives to a subprime mortgage include FHA, VA, or USDA loans if you qualify.
Not all borrowers qualify for a regular or “prime” mortgage loan, typically due to having poor credit. If a lender considers you to have a greater risk of default than other borrowers, you might qualify for what is known as a subprime mortgage.
Because of their role in the 2008-2009 financial crisis, subprime mortgages have a less than stellar reputation. It’s important for would-be borrowers to understand how subprime mortgages work and how to self-evaluate before agreeing to take one out.
Subprime mortgage: Definition and history
A subprime mortgage is an alternative offered to borrowers with low credit scores or other credit issues. Because a subprime borrower is seen as a greater risk of not paying off their loan, they are required to pay a higher interest rate. Because of this, these mortgages can be significantly more expensive than traditional conventional mortgages.
Note: Each lender determines their own definition of subprime status. Additionally, some may use different or more finely-tuned terms such as non-prime, near prime, or deep subprime.
Subprime mortgages are perhaps best known for their role in helping to create the housing bubble that led to the financial crisis of 2008-2009 and the Great Recession of 2007-2009. When the bubble burst many homeowners found themselves “underwater” with mortgage balances greater than the value of their homes.
Because of their role in the financial crisis, subprime mortgages have a negative connotation. Lenders have begun using the term “non-prime mortgage.” The main difference between the two is that non-prime mortgages are subject to tougher, more responsible underwriting.
This allows people who can demonstrate their ability to keep up with house payments, but who have suffered a recent financial loss or tragedy, the opportunity to own their own home.
See Insider’s picks for the top low credit score mortgage lenders>>
How do subprime mortgages work?
Although there is no one-size-fits-all number, generally speaking, borrowers with FICO credit scores in the low 600s and lower are considered subprime. The Consumer Financial Protection Bureau considers scores below 620 to be subprime, while the credit reporting agency Experian says that scores below 670 could fit into this category by some lenders’ definitions.
Some of the factors that have a negative impact on a borrower’s FICO credit score leading to subprime status are:
Missed payments on credit accountsCharge-offs, repossessions, or foreclosuresRecent bankruptcyHigh debt-to-income ratioNew to credit with no credit score
The mortgage rate associated with a subprime loan is dependent on four factors: credit score, the size of the down payment, the number of late payment delinquencies on a borrower’s credit report, and the types of delinquencies found on the report.
Quick tip: You can use Personal Finance Insider’s mortgage calculator to see how different interest rates would affect your monthly payment.
“Often, consumers don’t comprehend the risks of the financial products they’re signing themselves up for,” says Jeffrey Zhou, CEO of Fig Loans.
“The Consumer Financial Protection Bureau, a regulating body of Dodd-Frank, ensures that lenders offer appropriate financial products and loan terms that don’t financially hurt the consumers in the long run,” Zhou says. “Without the Consumer Financial Protection Bureau, lenders could offer borrowers excessive interest rates or overpriced financial products, making their financial situation worse. In short, it protects consumers from falling into the trap of possible lifetime debt from bad lenders and oversees financial activities in many financial industry segments.”
Subprime mortgage features
Because they don’t conform to typical mortgage standards, subprime or non-prime mortgages can come with a variety of different terms, rate structures, and requirements.
Often, subprime mortgages are adjustable-rate mortgages, meaning you’ll start with a rate that stays the same for a set amount of time then adjusts periodically depending on current market rates. But you can also find subprime mortgages that come with fixed rates, where your rate stays the same for the entire term.
You may be able to find subprime mortgages that spread out your payments over an even longer term than the typical 30 years, like a 40-year mortgage. Or the loan might be set up as an interest-only mortgage, where you only pay the interest each month for a set period of time. This type of setup can be risky and expensive.
Who offers subprime mortgages?
Following the subprime mortgage crisis, subprime lenders all but disappeared from the scene. They have since reappeared, largely rebranded as non-prime or non-QM (non-qualified mortgage) lenders. Fortunately, if you do not qualify for a prime mortgage loan, resources exist to help you find and identify vetted non-prime lenders near you.
For starters, check your credit report and credit score. You will need the score to eliminate lenders who would otherwise eliminate you. Check with trusted local banks and mortgage lenders who offer prime rate mortgage loans. Many traditional lenders also offer subprime (non-prime, if you prefer) mortgage loans.
Consider lenders that specialize in non-QM mortgage loans, such as Angel Oak or Carrington. A quick online search using terms such as “subprime, non-prime,” or “non-QM” mortgage loans should yield results. Finally, apply. The best way to find out if you qualify, is to apply for a loan or preapproval.
Should I get a subprime mortgage?
Just because you can get a subprime loan doesn’t mean you should. If you don’t qualify for prime mortgage now, the best thing to do is work on rebuilding your credit, paying off debt, and saving for a higher down payment.
If you’ve considered the pros and cons and think getting one of these mortgages makes the most sense for your situation right now, it’s a good idea to continue to work on your credit anyway.
“Have an exit plan,” advises Joshua Massieh, host at The Trading Fraternity. “Come into the transaction already thinking about how to refinance out of the loan or a timeline of when you are planning on selling the home.”
Although you will pay a higher interest rate with a subprime loan, the sky is not the limit. The government caps interest rates on subprime mortgage loans and lenders have to honor those caps.
Ultimately, a subprime, non-prime, or non-QM mortgage loan costs more, both in the short-term and in the long-term. If you can resign yourself to that, a subprime loan might be for you.
AdvantagesDisadvantages
Achieve homeownership and start building equity sooner
Potential to improve credit score through regular on-time payments
Government capped interest rate
High interest rate, fees
Increased risk of default due to high costs
Higher long-term cost
Subprime mortgage alternatives
Before you get into a subprime loan, consider the alternatives.
“Don’t think that you’re choiceless,” says Zhou. “There are other and even better options than settling for a subprime mortgage. You can qualify for a homeownership assistance program if you don’t meet the credit requirement. So don’t lose your hope of owning a home.”
Some alternatives include:
Federal Housing Administration (FHA) loans: FHA loans feature lower interest rates than conventional mortgages. You may be eligible for an FHA loan with a credit score as low as 500 with a 10% down payment or 580 with a 3.5% down payment.Veterans Affairs (VA) loans: VA loans are available to qualified veterans or members of the military community, such as a spouse or beneficiary. You may be able to purchase a home with little or no money down with a VA loan.UD Department of Agriculture (USDA) loans: There is no down payment requirement for a USDA home loan. If your income is limited and you want to purchase a home in an eligible rural area, you may qualify for this type of loan.
Subprime mortgages aren’t for everyone. If you’re not in a rush for housing, it’s probably better to improve your credit and qualify with a mortgage lender that offers prime loans. If you don’t have time to wait, look into one of the alternatives listed above.
What is a subprime mortgage FAQs
What is a subprime mortgage in simple terms?
A subprime mortgage is a home loan offered to borrowers who don’t qualify for a traditional mortgage because they have poor credit or otherwise are higher risk in the eyes of the lender.
What is an example of a subprime mortgage?
The exact definition of what type of credit is considered subprime varies from lender to lender. For example, if a lender typically won’t lend to borrowers with scores below 660 but it has a loan product with higher interest rates for borrowers with scores down to 580, that would be considered a subprime mortgage.
What are subprime mortgages called now?
You may sometimes see subprime mortgages referred to as non-prime. They may also fall under the umbrella of non-QM loans, which are those that don’t meet qualified mortgage standards set by Consumer Financial Protection Bureau.
