If you've paid attention to the news over the past year, then you no doubt heard a great deal of talk about the housing boom and potential bust in the United States. There are many factors that helped give rise to the boom. One was the use of tricky lending programs that enable people with shaky credit ratings to secure home loans. This same practice has contributed equally to the bursting of the housing bubble.
 Ariel Skelley/Getty Images Many people need subprime mortgages to break into the housing market. See more real estate pictures. |
The practice of lending money to people with a weak or limited credit history is called subprime lending. One misconception about the term "subprime" is that it refers to the interest rates attached to the loans. "Subprime" is actually a reference to the credit rating of the borrower. Subprime borrowers generally have a credit rating below 620 on a scale of roughly 300 to 900. Most consumers land in the mid- to high 600s and 700s [source: Bankrate.com].
Subprime rates can vary wildly. They're based on a variety of risk-based factors including:
- Credit score
- Size of down payment
- Number of delinquencies (credit hits)
- Type of delinquencies
The sharp rise in subprime mortgage lending began in the mid-1990s and accounted for roughly 20 percent of home loans in 2006 [source: Federal Reserve]. On the plus side, subprime mortgages allow people with poor credit a chance to get into a market previously unavailable to them with standard home loans. The downside of this scenario is that these loans are more likely to go into default, meaning that the borrower fails to make payments on the loan. The large number of foreclosures from subprime mortgages has had a drastic impact on the U.S. housing bust and overall economy. Lenders have also been hit hard, with many working in the red and some going under completely.
In a video from CreditLearningCenter.com, learn about your credit score -- why it's important, what it's used for and how you get yours. |
Another negative aspect of the subprime market is the rise in accusations that lenders target minorities -- a practice known as predatory lending. These lenders prey upon the inexperience of the borrower in many ways. They may overvalue your property, overstate your income or even lie about your credit score in order to set sky-high interest rates. They also encourage frequent refinancing to get a "better" rate, and then roll the high closing costs in to the loan.
| Another way subprime lending rears its ugly head is in the credit card industry. Subprime credit cardholders can expect to pay a variety of additional fees not typically found with prime cards. Yearly fees, up-front fees, and higher late and over-the-limit fees are common. The late payment grace period is also usually not available to a subprime cardholder. One fee typically leads to another -- the grace period isn't allowed, resulting in a late fee that's figured into the balance, leading to over-the-limit fees. The system itself seems geared toward making money off the people that had financial difficulties to begin with. If you have a subprime card, it's very important to stay on top of your payments for an extended period. This way, you may actually be able to improve your credit. |
In this article, we'll look at some examples of subprime mortgages to help you determine if one might be right for you. We'll also examine the subprime crisis and what's being done about it.
