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Subprime Mortgages

Getting a mortgage with a relatively low interest rate depends on a variety of factors, but one of the most important things to obtaining a mortgage at all is your credit score.

Millions of people in the United States have bad credit and this can be for a variety of reasons. Missing a payment or not being able to make the minimum are factors in having a low credit score.

This low credit score has prevented many people from obtaining a mortgage, but there are alternatives for people with credit problems.

The article, “Subprime Mortgages,” posted on Bankrate.com, May 1, 2006, gives an overview of this alternative type of mortgage for people with bad credit.

“Egregious credit problems, such as a recent foreclosure, will prevent you from getting a mortgage. But lesser credit flaws won't necessarily stop you from getting a home loan. An industry of subprime mortgage lenders has sprung up to serve the vast constituency of Americans who have credit problems.”

Credit scores in the U.S. are based on a scale of 300 to 900. A borrower is considered to be “subprime” if their credit score falls below 620. Most people who are normal consumers have a credit score between the 600s and 700s.

There are a few important differences between a subprime mortgage and a normal fixed-rate or adjustable-rate mortgage.

For people with excellent credit, there is not going to be much of a difference in rates when they are comparison shopping. But with a subprime loan there are various factors that must be taken into consideration, so the rates for these loans also vary greatly between competing lenders.

“Subprime loans have higher rates than equivalent prime loans. Lenders consider many factors in a process called "risk-based pricing" when they come up with mortgage rates and terms. This makes it impossible to generalize about subprime rates. They are higher, but how much higher depends on factors such as credit score, size of down payment, and what types of delinquencies the borrower has in the recent past (from a mortgage lender's standpoint, late mortgage or rent payments are worse than late credit card payments).”

There are also different payment options and penalties with subprime loans that the potential customer should be made well aware of.

“A subprime loan also is more likely to have a prepayment penalty, a balloon payment, or both. A prepayment penalty is a fee assessed against the borrower for paying off the loan early -- either because the borrower sells the house or refinances the high-rate loan. A mortgage with a balloon payment requires the borrower to pay off the entire outstanding amount in a lump sum after a certain period has passed, often five years. If the borrower can't pay the entire amount when the balloon payment is due, he/she has to refinance the loan or sell the house.”

There is also a large market for lenders who are looking to cheat subprime borrowers, and they must be very aware of these “predatory lenders.”

“There are several predatory tactics, and sometimes a lender will combine them. Some lenders soak naive borrowers with outrageous fees and sky-high interest rates. These lenders are likely to tell the borrower that his/her credit score is lower than it really is.”

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