Many families dream of owning their own home. For some buyers, a subprime mortgage allows them to make this dream a reality. While traditional home loans generally require a good credit score and strong credit history, a subprime mortgage is designed for people who may not meet the standards of traditional lending institutions.
What is a subprime mortgage?
A subprime mortgage is a type of home loan that is generally available to borrowers with lower than average credit ratings. Most borrowers who pursue this type of loan are not eligible for conventional home loans because of their higher-than-average risk of defaulting on their loan. Subprime lenders typically charge higher interest on home loans than a conventional mortgage lender would in order to compensate for the added risk of loaning to a subprime borrower.
Who is considered a subprime borrower?
In many cases, a subprime borrower has a credit score that is below 600 on a scale of 300 to 850. To put this in perspective, the average consumer as a credit score from the mid 600s to 700s. These borrowers are often limited to loans from subprime lenders due to a poor credit history. Filing bankruptcy or paying bills late are habits that frequently land borrowers in the subprime-lending category. In lieu of pursuing a subprime mortgage, prospective homebuyers with low credit ratings may want to work on rebuilding their scores prior to applying for mortgages. This may allow them to get better rates.
How are interest rates on subprime loans determined?
The interest rates that a lender offers on a subprime mortgage may very wildly. Several risk-based factors are used to determine the interest rate including:
- Credit score: Although there are several different formulas used to determine a credit score, they all consider some common factors like payment history, outstanding debt, length of credit history, new credit and the types of credit that you currently have.
- Payment history: Payment history allows lenders to see how well you pay your bills. This portion of your score is affected by the number of late payments, collection accounts and bankruptcies. The more recent these occurrences are, the bigger the impact they will have on your score.
- Outstanding debt: This factor evaluates how much debt a borrower currently has. Debts like auto loans, credit cards and home loans are frequently used in this calculation. Although credit cards are an important part of building your credit history, having many credit cards that are near their limits may significantly impact your score. Many credit bureaus consider credit card utilization of 25% or less to be ideal.
o Length of credit history: Part of your credit score is based on the length or age of a borrowers credit history. The longer they have had credit, the better it will look for their overall credit score. Many lenders consider your past payment habits to be a key indicator of your future actions.
- New credit: Each time a borrower opens a new account; it negatively impacts their score for a brief period of time. This portion of a borrowers score is also affected by the number of “hard inquiries” that they have had in the past year. A “hard inquiry” is when a consumer gives a lender permission to pull their credit. To the contrary, a “soft inquiry” is when a borrower pulls their own credit history. This has no affect on their score.
- Types of credit: This portion of a borrowers credit score considers the variety of their accounts. Lenders what to see how borrowers have handled various types of accounts including installment loans and revolving credit accounts.
- Number of delinquencies: Subprime lenders use the number of delinquencies on a borrowers account to determine how likely they are to pay their loan on time. Not only do they consider the number of late payments, but also the amount of time that they are past due. Payments that are 60 or 90 days late will likely impact a score more negatively than payments that are 30 days late. Either way, lenders want to see as few late payments as possible as this indicates that a borrower does not handle their finances responsibly.
- Size of down payment: Subprime lenders consider the amount of money that a borrower wants to put down on a home loan when determining their interest rate. While home loans typically require 20% down, the more a borrower puts down on a home, the less money they will need to finance. In most cases, a larger down payment can significantly decrease the interest rate of as subprime or conventional home loan.
- Type of delinquencies: When it comes to securing a subprime mortgage, all delinquencies are not created equally. Although lenders want to see as few delinquencies as possible, some are weighted more heavily than others. For example, a subprime lender may weigh a charge off or medical collection account less heavily than a more serious delinquency like a bankruptcy or tax lien.
What are the benefits of a subprime mortgage?
Despite higher interest rates, there are several benefits of a subprime mortgage. For one, subprime lenders give borrowers with a less than perfect credit history, a chance to bring their dream of owning a home to fruition. Other benefits include:
- Rebuild credit: A low credit score can make it difficult to get credit. This makes it hard to rebuild credit. A subprime mortgage gives borrowers with a less than perfect credit score a second chance. Over time, making on-time payments will improve their credit score and possibly even refinance later at a better rate.
- Build equity: Not only can renting be expensive, but also at the end of the lease renters are left with nothing to show for it. A subprime lender allows a borrower to own a home that they can build equity in. Years down the line, the homeowners may choose to borrow against some of this equity for major purchases like a college education or home improvements.
How do I find a subprime lender?
There are several ways to go about finding a subprime lender. Here are some ideas to get you started:
Call local credit unions. Call your local credit unions to inquire about a subprime mortgage. The unique non-for-profit business structure of many credit unions allows them to offer more products. This often includes some form of a subprime mortgage. A mortgage broker at your local credit union may be able to help you find exactly what you are looking for.
Check out the U.S. Department of Housing and Urban Development (HUD). The HUD maintains a database of Subprime and Manufactured Home Lenders. The list can be found here: http://www.huduser.org/portal/datasets/manu.html
Search online. With a little patience, borrowers can find subprime mortgage lenders online. Companies like NationStar Mortgage (https://www.nationstarmtg.com/), Ameriquest Mortgage Company (http://www.ameriquestmortgage.com) and E-loan (http://www.eloan.com) offer special mortgages for borrowers with less than perfect credit.