Getting a mortgage can be challenging process – investigating the types of mortgages on the market, the types of lenders you can get them from and the price range which suits you are all basic factors to consider. For many, the process of securing a mortgage can be made more difficult thanks to their credit score. Ranging from 300 to 850, your credit score indicates how financially reliable you are when it comes to commitments such as paying back loans and bills. Most consumers fall somewhere in the credit score region of the 600 or 700s, and therefore poor credit rating is attributed to anyone with a score under 620. If this applies to you then don't worry, a mortgage is still available to you – the subprime mortgage (although most sales people will not refer to this type of mortgage under this name and may instead try to euphemize the term with other labels such as 'non-prime' and 'near prime'). Here I explain the main features of a subprime mortgage, weighing its advantages and disadvantages so that you can decide if this type of mortgage really is best for you.
How Subprime Loans Differ To Typical 'Prime' Loans
If a subprime loan refers to those given to people with not-so-perfect credit scores, then a loan given to someone with an excellent credit score can be called a 'prime' loan. The difference between subprime and prime loans is mainly higher rates. When deciding upon the loan, lenders have to consider many factors in their 'risk-based pricing' process. Those people with a lower credit score are perceived as a higher risk, and therefore the subprime rates are higher. How much higher depends on the individual and the loan in question – e.g. the amount of the downpayment and the credit history of the person in question.
The Prepayment Penalty
Subprime loans are also more likely to feature a prepayment penalty clause. A prepayment penalty states that if the mortgage is repaid within a certain time (i.e. early) through refinancing or selling then a monetary penalty will occur. How much this will be depends on the remaining mortgage balance or a number of months worth of interest. Prepayment penalties that apply only to the refinancing of a property are called 'soft', whereas prepayment penalties that apply to both selling and refinancing are known as 'hard'. Borrowers should seriously consider these types of penalties before taking out the mortgage, as they can cause re-financing, an option which really can be useful, to be overruled due to inflated costs.
Balloon payments are also a common clause with subprime mortgages. This refers to a mortgage whereby the borrower pays a certain amount for the first period of the loan and then the remainder of the mortgage all at once after a specified period, usually five years. If the borrower cannot afford the final payment then they must refinance or sell the house, proving to be problematic if there is a prepayment penalty in place.
Subprime Mortgage Follies
Due to the nature of the subprime loan the interest rates are going to be higher, but borrowers should be wary of lenders who take advantage of this fact and try to con borrowers with unnecessarily high rates. They may try and do this is a number of ways, such as making the borrower believe that their credit score is lower than it really is, or pressuring borrowers to frequently re-mortgage their house, driving up interest rates in the first scenario and charging increasing closing fees in the second – all of which are adding to your total bill. Tactics such as these are often used by lenders who issue mortgages to people they know will not be able to re-pay it, thus forcing them into foreclosure and selling the property.
Weighing Up Your Options
As you can surmise there is a lot to consider when it comes to subprime mortgages. Although it may be the only type of mortgage option available to you if you have a poor credit rating, is it really worth the risk? Most homeowners cannot afford a sudden balloon payment at the end of their loan, and the prepayment penalties make refinancing or selling the house expensive too. Sometimes working on improving your credit score could be a better option. If you do decide to go for a subprime loan carefully consider your payment schedule, and protect yourself against predatory lenders as described above by finding out your own credit score ahead of time and researching any lenders you're considering.