If you are seeking information about mortgages there is a good chance you are looking to purchase a home or refinance an existing mortgage.  With so many options to choose from (banks, brokers, credit unions, etc.) the chances of choosing a mortgage product that might not be the most beneficial has certainly increased in recent times.  With some mortgage banks that have recently gone under, the need to perform your own due diligence before making what could be a 30-year financial commitment could potentially save thousands in interest paid over the loan.

In more extreme cases, the right loan program could keep you in your home should rates in secondary mortgage markets fluctuate. Subprime lending (near-prime, non-prime, or second chance lending) is a financial term that was popularized by the media during the credit crunch of 2007 and involves financial institutions lending in ways which do not meet "prime" standards to an extent which puts the loans into the riskiest category of consumer loans typically sold in the secondary market.

These standards refer to the size of the loan, "traditional" or "nontraditional" structure of the loan, borrower credit rating, ratio of borrower debt to income or assets, ratio of loan to value or collateral, documentation provided on those loans which do not meet Fannie Mae or Freddie Mac underwriting guidelines for prime mortgages (are "non-conforming"). Although there is no single, standard definition, in the US subprime loans are usually classified as those where the borrower has a Fico Score below 640. Subprime lending encompasses a variety of credit types, including mortages, auto loans, and credit cards.

Subprime could also refer to a security for which a return above the "prime" rate is adhered, also known as C-paper.

Subprime borrowers show data on their credit reports associated with higher default rates, including limited debt experience, excessive debt, a history of missed payments, failures to pay debts, and recorded bankruptcies.

Proponents of subprime lending maintain that the practice extends credit to people who would otherwise not have access to the credit market.

What is subprime lending?

Subprime lending evolved with the realization of a demand in the marketplace for loans to high-risk borrowers with imperfect credit. The first subprime was initiated in 1993. Many companies entered the market when the prime interest rate was low, and real interest became negative allowing modest subprime rates to flourish; negative interest rates are hand-outs, such that the more you borrow the more you earn. Others entered with the relaxation of usury laws. Traditional lenders were more cautious and historically turned away potential borrowers with impaired or limited credit histories. Statistically, approximately 25% of the population of the United States falls into this category. In 1998, the Federal Trade Commission estimated that 10% of new-car financing in the U.S. was provided by subprime loans, and that $125 billion of $859 billion total mortgage dollars were subprime

In the third quarter of 2007, subprime ARMS only represented 6.8% of the mortgages outstanding in the US, yet they represented 43.0% of the foreclosures started. Subprime fixed mortgages represented 6.3% of outstanding loans and 12.0% of the foreclosures started in the same period.

Subprime Lenders

To access this increasing market, lenders often take on risks associated with lending to people with poor credit ratings or limited credit histories. For example, they would lend money to consumers that have bad credit. The FICO score indicates to the lender the rate of default. Those with credit scores below 620 have a much higher default rate than those with credit score above 720. However, if a borrower has sufficient income then he or she may qualify for a subprime mortgage product. Subprime loans are considered to carry a far greater risk for the lender due to the aforementioned credit risk characteristics of the typical subprime borrower. Lenders use a variety of methods to offset these risks. In the case of many subprime loans, this risk is offset with a higher interest rate. In the case of subprime credit cards, a subprime customer may be charged higher late fees, higher over-the-limit fees, yearly fees, or up-front fees for the card. Late fees are charged to the account, which may drive the customer over their credit limit, resulting in over-the-limit fees. These higher fees compensate the lender for the increased costs associated with servicing and collecting such accounts, as well as for the higher default rate.

Borrower profiles

Subprime loans can offer an opportunity for borrowers with a less-than-ideal credit record to become a home owner. Borrowers may use this credit to purchase homes, or in the case of a cash-out refinance, finance other forms of spending such as purchasing a car, paying for living expenses, remodeling a home, or even paying down on a high-interest credit card. However, due to the risk profile of the subprime borrower, this access to credit comes at the price of higher interest rates, increased fees and other increased costs. Subprime lending (and mortgages in particular) provides a method of "credit repair"; if borrowers maintain a good payment record, they should be able to refinance into mainstream rates after two to three years. In the UK, most subprime mortgages have a two or three-year tie-in, and borrowers may face additional charges for replacing their mortgages before the tie-in has expired.