What is a subprime mortgage?

House on mortgage

Q. What is a subprime mortgage?

A. A subprime mortgage is given to someone with a poor credit history and score, usually below 620 on the scale created by Fair Isaac Corp. and used by most lenders.

About 20% of consumers have scores in this range and subprime loans have accounted for about that percent of all mortgages the past couple of years.

Subprime loans charge higher interest rates, and impose stiffer penalties if you're late with a payment, because the borrower is considered to be a bigger risk.

Exactly how much subprime loans cost varies from lender to lender. But a borrower with a credit score of 620, for example, should expect to pay 1.25% to 2.5% more than a borrower with a score of 670 and above who qualifies for a lender's best rate. If that score falls to 580, figure 2.5% to 4% more.

Subprime loans have been in the news lately because lenders were making subprime loans to people who could not afford to make the payments. Many are now behind in their payments or facing foreclosure.

This unfortunate situation has forced some changes in subprime lending. Qualifications are being tightened and no one is providing 100% financing anymore. You have to come up with a down payment of at least 3%.

These changes are good, as they will save some people from getting a mortgage that is beyond their means to repay. If your FICO score is below 620 and you are considering applying for a subprime mortgage, be sure you know how much you will have to pay every month and whether the rate will go up, when it will go up and by how much. Also, if you get an adjustable-rate mortgage, be sure any prepayment penalty is expires after three years.

With rates the way they are today, you should probably get a 30-year, fixed-rate loan, where the payments (principal and interest) will stay the same for 30 years --although taxes and insurance will increase.

Also, if you get a subprime loan there is no reason to think you will be stuck with it for 30 years. You can work on improving your credit score and if you can push it up to 700 or better in two or three years, you can always refinance and get a regular mortgage with a better rate.

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