What Is a Subprime Mortgage?

Q: Can I refinance a subprime mortgage?

You can refinance a subprime mortgage , often to secure better terms once your credit score improves.

Q: What happens if I default on a subprime mortgage?

Defaulting on a subprime mortgage can lead to foreclosure , damaging your credit score and making it harder to obtain loans in the future.

Subprime mortgages are loans for borrowers with poor credit, typically featuring higher interest rates and fees. While costly, they can be a viable option for those who need to secure a home despite credit challenges.

By Zachary Romeo, CBCA

Reviewed by Ramsey Coulter

Edited by Megan Hull

Updated: December 12, 2024

Advertising & Editorial Disclosure

Securing the right mortgage can be challenging, especially if you have less-than-perfect credit. A subprime mortgage is a type of loan designed for borrowers with lower credit scores or limited credit history. Understanding what a subprime mortgage entails can help you make informed decisions about your home financing options.

By learning about the benefits and risks, you can better determine if it suits your financial situation. We’ll guide you through everything you need to know about subprime mortgages, from their characteristics to alternatives you might consider.

Key Takeaways

A subprime mortgage is a loan for borrowers with poor credit, typically offered when they don’t qualify for prime mortgages.

A subprime mortgage can help you achieve homeownership, but you must be prepared for higher interest rates and fees.

Securing a subprime mortgage can be strategic when expecting an increase in income or finding a rare bargain property.

How Subprime Mortgages Work

A subprime mortgage, also known as a nonprime mortgage, is a loan offered to borrowers who don’t meet the criteria for a prime mortgage. These loans typically come with higher interest rates due to the increased risk lenders take on with subprime borrowers.

Eligibility for a subprime mortgage often includes having a low credit score, usually below 620. Borrowers might also have a high debt-to-income ratio, meaning they owe a significant amount of money compared to their income. Limited credit history can make one eligible for a subprime mortgage, as lenders see this as a higher risk.

WHAT IS A SUBPRIME BORROWER?

A subprime borrower is someone who doesn’t qualify for a prime mortgage due to factors like a low credit score, high debt-to-income ratio or limited credit history. For example, if you have a credit score of 580 and significant student loan debt, lenders might see you as a higher risk. Knowing what a subprime borrower is can help you understand why you might be offered a subprime mortgage instead of a traditional one.

Differences Between Prime and Subprime Mortgages

Both prime and subprime mortgages allow you to finance a home purchase. However, understanding the differences between these mortgage types can help you choose the right loan. Below is a comparison table to illustrate these differences.

Comparison Areas	Prime Mortgages	Subprime Mortgages
Definition	Loans for borrowers with good credit scores and stable financial histories.	Loans for borrowers with lower credit scores or unstable financial histories.
Adherence to Fannie Mae and Freddie Mac	Typically conform to standards set by Fannie Mae and Freddie Mac.	Often do not conform to the standards set by Fannie Mae and Freddie Mac.
Interest Rates	Lower interest rates due to lower perceived risk by lenders.	Higher interest rates due to higher perceived risk.
Down Payment	Usually require a lower down payment, sometimes as low as 3%.	Often require a higher down payment than a prime loan for the same amount.
Loan Amounts	Can qualify for higher loan amounts due to better credit and financial standing.	Typically qualify for lower loan amounts due to increased risk.
Fees	Generally have lower fees and fewer additional costs.	Higher fees and more additional costs.
Repayment Periods	Standard repayment periods, usually 15 to 30 years.	May take longer to repay compared to prime loans of the same size.

INTEREST RATES ON A SUBPRIME MORTGAGE

A subprime mortgage rate is higher than a prime mortgage rate due to the increased risk lenders take on when lending to borrowers with poor credit. While prime mortgages can have fixed or adjustable rates, subprime loans are often adjustable-rate mortgages (ARMs). The interest rate can rise significantly, leading to higher monthly payments.

Types of Subprime Mortgages

You may encounter various types of subprime mortgages designed to meet different borrower needs. Understanding these options helps you find the best fit for your situation. Below are some common types to consider:

[Adjustable-Rate Mortgage (ARM)](https://www.moneygeek.com/mortgage/adjustable-rate-mortgage/)

ARMs start with low introductory interest rates that shift to a variable rate after a specified period, usually one year. This rate is tied to a central banking index like the Monthly Treasury Average Index. When the rate changes, often annually, it can significantly increase your monthly mortgage payment, potentially straining your budget.

Extended-Term Mortgage

These mortgages have repayment periods of 40 or even 50 years compared to the conventional 30-year term. While monthly payments might be lower, the higher interest rates typical of subprime mortgages can mean paying hundreds of thousands of dollars more over the life of the loan.

[Interest-Only Mortgage](https://www.moneygeek.com/mortgage/interest-only-mortgage/)

This option allows you to pay only the interest for the loan's first five to seven years. After this period, you must start paying down the principal or refinance. Interest-only mortgages can be risky if you rely less on the lower payments and face difficulties later.

Dignity Mortgage

With this mortgage, you make a down payment of at least 10% and pay a high interest rate initially. If you make timely payments for a set period, usually five years, the interest paid lowers the loan balance, and the rate is reduced to the prime rate. This can benefit those who can manage higher initial payments.

Pros and Cons of Subprime Mortgages

Securing a subprime mortgage can make homeownership possible for those with lower credit scores. However, it’s important to consider both the benefits and risks. While it opens doors to owning a home, it also comes with higher interest rates and potential financial strain. Below is a table outlining the pros and cons of subprime mortgages.

Pros

Opportunity for Homeownership: Allows those with poor credit to buy a home.
Credit Improvement: Regular, timely payments can help improve your credit score.
Flexible Criteria: Less stringent eligibility requirements compared to prime mortgages.
Shorter Approval Time: May have a faster approval process than traditional loans.
Various Options: Multiple subprime mortgage types can suit different financial situations.

Cons

Higher Interest Rates: Comes with significantly higher interest rates than prime mortgages.
Adjustable Rates: Many subprime mortgages have variable rates that can increase over time.
Higher Fees: Often associated with higher fees, including origination and late payment fees.
Longer Repayment Terms: Longer repayment periods can result in paying more interest over the loan term.
Risk of Foreclosure: Higher monthly payments can increase the risk of default and foreclosure.

When to Get a Subprime Loan

Despite some disadvantages, a subprime mortgage can be a viable financing option in certain situations. The key is knowing when it’s best to secure one and when to wait. Let’s explore several scenarios.

A Rare Opportunity

Angel has been renting for years while saving up for her first home. One day, she stumbles upon a charming fixer-upper in a desirable neighborhood, priced well below market value. The house is a rare bargain, and Sarah knows it will only stay on the market for a little while.

Despite her diligent saving, Sarah's credit score isn't stellar due to some past financial missteps. She's worried she won't qualify for a prime mortgage in time to secure the deal. Consulting with a mortgage broker, she learns that a subprime mortgage could allow her to purchase the home quickly despite the higher interest rate.

IS A SUBPRIME MORTGAGE A GOOD CHOICE?

In Angel's case, getting a subprime mortgage might be a smart move. The bargain price of the home outweighs the higher interest costs, and securing the property now could lead to significant equity gains once it's renovated. While she should be cautious of the higher payments, the opportunity to buy this rare find justifies considering a subprime mortgage.

A Risky Stretch

Paul is a single father who works two jobs and dreams of owning a home to provide stability for his children. After months of searching, he finds a modest house within his budget. However, due to his low credit score, he only qualifies for an adjustable-rate mortgage (ARM) with a subprime lender.

The introductory payments are already a stretch for Paul's current income, and he's concerned about future rate increases. He consults a mortgage broker to explore his options but feels pressured to move forward quickly to secure the house.

IS A SUBPRIME MORTGAGE A GOOD CHOICE?

For Paul, a subprime mortgage with an ARM is not a wise choice. Given his tight budget, any increase in the adjustable rate could make the payments unmanageable, potentially leading to financial distress or foreclosure. Paul should continue improving his credit and saving more before committing to a mortgage that poses such significant risks.

Future Gains

Emily, a marketing executive, has found her dream home in a bustling city. Her current credit score limits her to subprime mortgage options, but she expects a significant salary increase in the next six months due to a recent promotion. She also anticipates receiving an inheritance from her late grandmother’s estate within the year.

Emily consults a mortgage broker, who suggests that she secure a subprime mortgage now and plan to refinance later. The broker advises that with her expected financial boost, she can make a larger down payment and qualify for better loan terms in the near future.

IS A SUBPRIME MORTGAGE A GOOD CHOICE?

In Emily’s situation, a subprime mortgage could be a strategic decision. With a reliable increase in income and an inheritance on the horizon, she can manage the higher initial payments and refinance to more favorable terms later. This approach allows her to secure her dream home now while planning for improved financial stability soon.

A Better Alternative

Mael, a recent college graduate, is eager to buy his first home. His low credit score, due to student loans and limited credit history, qualifies him only for subprime mortgage options. However, his aunt, who has excellent credit, offers to co-sign his mortgage application. That allows him to qualify for much better loan terms, including a lower interest rate and a smaller down payment.

IS A SUBPRIME MORTGAGE A GOOD CHOICE?

For Mael, opting for a subprime mortgage is not advisable. With the option of a co-signer with good credit, he can secure a prime mortgage with more favorable terms. This reduces his overall financial burden and provides a more stable path to homeownership, making the co-signed loan a significantly better choice than a subprime mortgage.

Alternatives to Subprime Mortgages

If you determine that a subprime mortgage is not the best move for you, it doesn't mean you have to put your home purchase on hold. There may be other options you can explore. Below are some alternatives to consider that might better suit your financial situation.

Alternative	Benefits	Why They're a Good Alternative
FHA Loans	Lower down payment requirements More lenient credit score criteria	Provides access to homeownership with less stringent financial requirements.
VA Loans	No down payment needed No private mortgage insurance (PMI)	Ideal for eligible veterans and active-duty service members with lower credit scores.
Credit Unions	Personalized service Lower fees and interest rates	Credit unions often offer more flexible lending criteria and support for members.
Community Banks	Focus on local borrowers Potential for more customized loan terms	Community banks may be more willing to work with borrowers to find suitable solutions.

FAQ About Subprime Mortgages

The topic of subprime mortgages can be complex, leading to many questions from homeowners. We've compiled answers to commonly asked questions because understanding these details can help you make informed decisions.

What is considered a subprime mortgage?

A subprime mortgage is a loan offered to borrowers with low credit scores or poor credit histories. These loans typically have higher interest rates to offset the increased risk to lenders.

Can a subprime mortgage help me build my credit?

Making consistent, on-time payments on a subprime mortgage can help improve your credit score over time.

Can I refinance a subprime mortgage?

You can refinance a subprime mortgage, often to secure better terms once your credit score improves.

What happens if I default on a subprime mortgage?

Defaulting on a subprime mortgage can lead to foreclosure, damaging your credit score and making it harder to obtain loans in the future.

How can I lower my subprime mortgage interest rate?

Improving your credit score, making timely payments and refinancing when eligible can help lower your subprime mortgage interest rate.

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About Zachary Romeo, CBCA

Zachary Romeo is a certified Commercial Banking and Credit Analyst (CBCA), and the Head of Loans and Banking at MoneyGeek. Previously, he led production teams for some of the largest online informational resources in higher education, with over 13 years of experience in editorial production.

Romeo has a bachelor's degree in biological engineering from Cornell University. He geeks out on minimizing personal debt and helping others do the same through people-first content.

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