What are Subprime Mortgages

A subprime mortgage is a mortgage which is granted by a subprime lending institution to those who do not meet the qualifications to be approved for a conventional bank mortgage. The banks do not grant subprime mortgages because the applicant may have difficulty maintaining the payment schedule. However, a subprime lending institution is willing to take that risk, balancing it out against correspondingly higher interest rates for subprime borrowers.

A subprime mortgage is inherently riskier than a standard mortgage. Because these loans are given to people who, for one reason or another, cannot qualify for a conventional mortgage, the risk of default is higher for a subprime mortgage than it is for a standard mortgage. As a result, the mortgage rates charged by subprime lenders are well above the prime lending rate.

There are many reasons why a person may not be approved for a conventional mortgage. Some of the most common are low income, low credit rating, a broad-sector credit freeze, a desire for a more expensive house than has been approved under a conventional mortgage, or an expectation that the investment income from the house will cover the mortgage payments.

In conventional mortgages, mortgage payments are supposed to make up only 1/3 of total income. However, many low-income families spend much more than that on rent. When they buy a house, they expect to pay the same percentage of their income on mortgage payments. A subprime mortgage can give them the opportunity to own their own home.

However, some people who do qualify for conventional mortgages prefer to take out a larger subprime mortgage and buy a larger house. In effect, this creates the same situation as if a low-income family spends a larger percentage of income on rent, except that this is by choice and not by necessity.

Banks usually deny mortgages to those who have credit ratings below 600, seeing them as poor risks for repayment. However, a low credit rating is not necessarily the result of a habit of poor repayment. It may simply be the result of limited debt experience. In this case, the lack of an extensive credit history could mean that the person is very careful about living within their budget.

Traumatic life events, such as unemployment, serious illness, or divorce, can also force late repayments over a short period of time, and may even lead to creditor settlements or bankruptcy. Although these events are a 1-time thing, their effects remain on the record for 7 or even 10 years.

In a broad-sector credit squeeze, banks often limit credit to their safest clients. They may be reluctant to lend to anyone except those who have high earnings, high savings, and high credit ratings, and who have already established a strong history with the bank. This leaves many other people unable to obtain a conventional mortgage, even though they might have qualified normally in normal times. If these people have a conventional mortgage that is coming up for renewal, they may be forced to take out a subprime mortgage instead.

Prior to 2007, some subprime lenders were willing to give mortgages to people without income or assets, on the basis that the house would soon be sold for a higher price, which would repay the mortgage and make a profit for the borrower. These NINJA mortgages (no income, no job, no assets) were the first to default when the housing bubble burst.