What is a Subprime Mortgage?

If you listen to the mainstream media, you'd start to believe that subprime loans include anything with an arm, adjustable interest rate or affected by declining home values.  You might also start to believe that "subprime" and predatory lending are the synonymous. This is not the case.  The confusion isn't limited to journalists and politicians.  Even those in industry seem to disagree and be confused as to how exactly to define subprime loans. 

Traditionally, a subprime mortgage is a loan provided to someone with "subprime" credit – either because of bad credit or too little credit history.  Although competing banks have different lending criteria, generally anyone with a credit score below 650 could only qualify for "subprime" lending.  In the past few years, however, the types of loans considered to be "subprime" have increased to include: (1) persons with a high debt to income ratio – generally above 35%; (2) high loan to value ratios – generally above 80%; and (3) certain loan programs – such as interest only loans.  Although purists would not include these in the definition of "subprime loans", it would be difficult to discuss the current state of the home mortgage market without such a broad definition of subprime. 

It is important to remember that "subprime" does not mean predatory lending or a bad lending decision.  Subprime loans made it possible for people with lower credit scores to own their own home.  Some individuals took out subprime loans to purchase a larger home than they would generally qualify for (with the idea that they would grow into their home) or to purchase an investment property.  Predatory lending, on the other hand, often involves brokers lying to prospective home buyers about interest rates or other terms of the mortgage. 

What Are the Issues in this Mortgage Meltdown?

The term "subprime mortgages" is often used as the catch-all phrase to describe the various problems plaguing the mortgage lending industry.  These problems, however, go far beyond loans made to people with less than good credit.  Instead, problems like mortgage fraud, depreciating property values, rising interest rates, and securitization of loan portfolios extend to both prime and subprime mortgages.  That said, it is important to understand how these problems affect the prime and subprime mortgage markets differently.

For example, mortgage fraud is not restricted to subprime markets.  Identity theft, falsified employment and credit information and taking out multiple mortgages with different lenders at the same time are all types of fraud affecting both the prime and subprime markets.  That said, fraud is more prevalent in subprime loan programs.  Why?  One reason is a common subprime loan practice that allowed borrowers to state their income and/or assets without requiring proof and or verification by the loan officer.  These are known as "no-doc", "low-doc" or SISA (stated income, stated asset) loans.  Critics of this practice also call these "liar loans" because many borrowers and their brokers lied about income and assets in order to qualify for the loan. 

Similarly, declining property values and increasing interest rates affect borrowers of both prime and subprime loans.  The greater impact, however, is on subprime mortgages, which were more likely to have an adjustable rate, started at a higher interest rate and include a greater percentage of people with a high debt to income ratio. 

So, next time you talk about the troubles surfacing in the mortgage lending industry, remember that there are often differences between the prime and subprime markets that need to be understood and appreciated in order to face the challenges ahead.

Comments

[Payday Loans]

“The confusion isn't limited to journalists and politicians. Even those in industry seem to disagree and be confused as to how exactly to define subprime loans.” Thanks for posting this information. I agree in this statement. Most of us are confused of what Subprime Mortgage means and what is the difference between subprime mortgage and predatory lending. According to my research Subprime Mortgage is a type of mortgage that is normally made out to borrowers with lower credit ratings. Now I know what subprime mortgage really means. This site talks about other issues in the loan industry and the recent news about predatory lending: http://personalmoneystore.com. No Fax Payday Loans also have been discussed mainly in their blog.

[first home buyer loan]

I do not understand how people who buy homes thought that by not putting up a good down payment that they deserved a 300k or higher home. I go back and try to blame the mortgage companies but no-one forced the people to buy homes that they knew they could not afford. It was greed in both parts the mortgage companies wanted to make money and some home owners wanted to flip.

[ameeta walia]

Thank for this clarification. I've been wanting to know the different between the two--subprime and prime mortage.

It's amazing how much information net has for all of us. From simiple things to the larger issues.

ameeta