Subprime mortgages have been in the news lately, as some contend that predatory lenders are using subprime mortgages to fleece low-income buyers. While predatory lenders are in the minority, they give the rest of the mortgage industry a bad name.
What is a subprime mortgage?
A subprime mortgage is for those prospective home buyers with credit scores under 620. The range for credit scores is from 300 to 900, with 300 being the worst, and 900 being the absolute best. Most borrowers have credit scores in the 600's and 700's.
If you've been late in paying bills, have been delinquent in paying credit card or other credit bills, your credit score is going to drop. And, once it drops below 620, you're in subprime territory.
Chances are, lenders will not use the term "subprime" when discussing a mortgage with you.
Even if your credit score is below 620, that doesn't mean that you don't have options when it comes to mortgages. Shop around. Subprime lenders use a variety of methods to determine the risk in issuing mortgages. Thus, rates can vary, sometimes by a lot.
Interest rates for subprime mortgages are higher than for "prime" mortgages. How much higher depends upon a number of factors: your credit score, the amount you're applying to the down payment, and what types of delinquencies you have in your credit record that resulted in a score of under 620. Lenders will look at some delinquencies as more serious than others. A delinquent hospital bill, for example, isn't viewed as badly as late mortgage or rent payments.
In all likelihood, a subprime mortgage will have either a prepayment penalty or a balloon payment. Or maybe both.
A prepayment penalty is a fee that you would have to pay if you sold the house or refinanced the mortgage too early. A balloon payment clause in a mortgage means that the entire mortgage balance must be paid in full after a certain period of time, often as little as five years. If you can't pay the entire mortgage balance when the balloon payment is due, you'll either have to refinance the loan, or sell the house.
As mentioned at the beginning of this article, there are predatory lenders who will use all sorts of methods to cheat you. Some lenders may tell you that your credit score is lower than what it actually is. Other predatory lenders will offer you outrageously high interest rates, or tack on fees that drive your monthly payments through the roof.
Predatory lenders often will try to pressure borrowers into refinancing the mortgage frequently. The lender will then charge higher than normal closing fees for the refinance, and will roll those closing costs into the mortgage balance. Or the lender will issue a mortgage to someone who obviously doesn't have the means to repay the mortgage.
These tactics are designed to drive the borrower further and further into debt, until the borrower can't repay the mortgage. The predatory lender has already made a lot of money with the high closing costs and with the refinancing. The next step is for the lender to foreclose on the home, and make money by selling it.
A subprime mortgage doesn't have to be an invitation to disaster. Subprime mortgages can be a useful tool for those who've had credit problems in the past.
Protect yourself against unscrupulous lenders by doing your homework. First, find out what your credit score really is. Talk to several mortgage lenders before you make your decision. Also, ask anyone you know who has a subprime mortgage about the lender he or she is dealing with. Doing your homework at the beginning will result in saving a lot of money later on.
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