Subprime Loans

When a homebuyer applies for a mortgage, the bank will take both their FICO credit scores and their debt to income ratio into consideration before lending them money to purchase a new home. A homebuyer with poor credit history or a high debt to income ratio might not qualify for a traditional loan because the lender will not be confident in buyer’s ability to repay the loan.

Instead of turning away a buyer with low credit scores, the bank might offer them a subprime loan. Given the elevated risks of lending to a buyer who has poor credit, these loans typically come with much higher interest rates than a conventional loan would have. A subprime loan will usually have been ARM (adjustable rate mortgage) in which the interest rate can change within a designated period.

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Who Benefits from a Subprime Loan?

  • A homebuyer who has previously foreclosed on a property
  • Buyers with low credit scores
  • Someone who otherwise would not qualify for a traditional loan or an FHA loan

The Risks of Borrowing Without Credit

These loans were very popular during the housing bubble in the mid-2000’s. Many banks would offer subprime loans with 100% financing to buyers with less than ideal credit. This unregulated lending to financially unstable buyers often resulted in foreclosure. After the market crashed in 2008, regulations were set for this type of financing. Currently, most banks do not offer subprime loans as an option and will steer a prospective buyer towards an FHA loan.

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How to Limit Risk with a Subprime Loan

In order to limit risk of defaulting on a subprime loan, there are few things that the buyer must take into consideration.

  • Although you might qualify now, can you actually afford this loan in the long run? Signature Lending Services can help you look at your debt to income ratio and determine how much you can comfortably afford for monthly mortgage payments.
  • Are you confident that your credit score will improve in a short time period? In this case, you might have a chance to refinance and secure a loan with better terms and a lower interest rate. The subprime loan will generally have a much higher interest rate than a conventional loan, so you will want to take advantage of refinancing for a lower rate once your credit scores improve.
  • Are you able to afford a large down payment? Paying a large amount of the loan upfront will to help keep your monthly payments low and mitigate the risk of foreclosure.