What is a subprime mortgage?
This refers to a housing loan that is offered to borrowers who have a poor credit history. This type of a mortgage is granted to individuals whose credit scores are 640 or below 600 because they cannot qualify for getting a conventional mortgage due to low credit scores. In most cases, these borrowers have been delinquent, have low credit scores, bankrupt and/or have low income. Since the lender is at a greater risk lending money to such borrowers, these loans may have greater closing costs, higher interest rates or require more down payment from the borrower to compensate the risk. However, it is important to understand that lenders are different and they are not obligated to offer you the best deal. Therefore, you can qualify for a better loan from another lender since brokers and lenders may differ. You, however, need to do a thorough research to find a good lender who will offer you the best deal.
Types of subprime loans
Here are the different types of subprime mortgages:
The interest rate on a fixed interest mortgage does not change throughout the term of the loan. In subprime mortgages, these loans are given for a 40 or 50-year term rather than the standard 30 year period. With the increase in payment duration, monthly payments of the borrower are lowered although these loans have higher interest rates. Sine fixed interest mortgages can vary from one lender to another, take your time to research for the lender who offers the best interest rates.
Here, borrowers only pay the interest for a given period of time typically five, seven or ten years. After the agreed period of paying the interest is over, the borrower can either refinance the mortgage or start paying the principal. These mortgages are ideal for borrowers whose income fluctuates from time to time and he/she wants to buy a home. However, the borrower should be expecting the income to rise in a few years because he/she will have to pay the principal after all.
Adjustable rate mortgages (ARM)
In the ARM, borrowers start by paying a fixed interest rate for a short period of time (the first 2 or 3 years of a 30-year mortgage) but later switches to a floating rate. The floating rate to be paid is determined based on an index plus a margin. One of the advantages of ARMs is that it allows borrowers to make low monthly payments for a given period of time while still giving them time to improve their credit scores. With improved credit scores, the borrower may opt for refinancing after the flat rate period is over.
As a new type of subprime loan, it allows borrowers to make a 10% down payment with an agreement of paying the higher interest rate for a set period (usually 5 years). If the borrower is able to make the monthly payments as agreed on time, the amount of money paid goes towards reducing the mortgage balance after 5 years. Since the borrower has made monthly payments as agreed, the interest rate is also lowered to prime rates.
With subprime lending, a lot of people can be able to buy homes. However, with the high-interest rates, closing costs and high down payments, there are high chances that borrowers will end up defaulting on their loans. Inability to pay the loan will affect the borrower’s credit score and the lender too because he/she will not be able to get his/her money back.
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