Sunday, 5 Feb 2023

What Is a Subprime Mortgage?

Are you ready to buy a house?

You’ve started looking, but you know your credit score might not be a little low. You have some money for a down payment, but it might not be enough. In short, you’re worried about taking the next step to secure a mortgage. You’re not quite sure if you have what it takes. You’ve maybe heard that a subprime mortgage might be an option for you, but what is a subprime mortgage?

In this article, we’ll take a look at this question and more.

What Is a Subprime Mortgage?

Before getting into subprime mortgages, let’s talk a little about prime mortgages. Also known as conventional loans, a prime mortgage is available to highly qualified borrowers who offer less risk to lenders.

When you fill out an application, you’re typically graded from A to F, with an A given to those with the highest credit scores. The lower your rating, the more likely you’ll need to explore alternative options.

Subprime mortgages are loans granted to borrowers who have low credit scores. These borrowers would not be approved for most conventional mortgage loans because they have a higher risk factor of defaulting on the loan.

Credit scores range from 300 to 850. They are split into five separate categories to represent your creditworthiness:

  1. 800–850 is Excellent: Borrowers are low-risk and have an easier time securing a loan.
  2. 740–799 is Very Good: Individuals have demonstrated positive credit behavior and have an easier time securing credit.
  3. 670–739 is Good: Individuals above 670 are generally accepted as low-risk borrowers.
  4. 580–669 is Fair: This is often where subprime borrowers fall; individuals are considered higher risk and may have trouble qualifying for loans.
  5. 300–579 is Poor: You’ll need to take steps to improve your credit before being eligible for a loan.

Understanding Subprime Mortgages

Subprime mortgages allow people to qualify for homeownership who may not have qualified through conventional sources. Subprime mortgages:

  • Give people with low credit scores a chance to own a home without going through years of working at establishing a better credit history.
  • Help people fix credit scores, using them to better their financial standing with other creditors as they pay off debt.

When you’re ready to buy a new home, a quick search will pull up an array of interest rate options. Those “headline” interest rates are advertised as top-tier, offered to prime or conventional mortgage borrowers with the very best credit history. Interest rates on subprime mortgages will be higher and may require larger sums of money to secure the loan.

Depending on the mortgage lender, you’ll find several different types of subprime mortgages:

Fixed Rate

It works like a conventional loan where the mortgage has a set interest rate and monthly payment rate for the life of the loan. The difference is a subprime fixed-rate loan often has longer terms, such as a 40-year loan repayment schedule instead of the typical 30 years for a conventional.

Adjustable Rate

Adjustable-rate mortgages, also known as ARMs, create a loan where the first few years are at a fixed rate, followed by readjustment periods for the remaining loan. A 3/27 ARM would give a fixed interest rate for three years, followed by yearly adjustments for the remaining 27 years. It’s adjusted according to the current market rate, which could be higher or lower than when you first took out the loan.

Zero-Down Payment

For many homeowners, the biggest obstacle to buying a house is coming up with a down payment. Putting less money down could mean you can get into your own home faster. However, mortgage lenders consider it a higher risk, so you’ll receive higher interest rates and increased monthly payments as a tradeoff.

A Note About Lenders

Lenders often try to get creative with their financing, which can also put homebuyers at risk. The Consumer Financial Protection Bureau, an agency created as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, regulates subprime mortgages as a way of further protecting the consumer.

When you’re thinking of homeownership and are ready to research mortgage loans, start by getting to know potential servicers and use their educational tools to learn more about the process.

Is a Zero-Down Mortgage Right for You?

Zero-down mortgages are attractive to homebuyers because they require no down payment to purchase a home. Often known as 100 percent financing, a zero-down mortgage can get you into your own home without the need to build up substantial cash reserves to finance the transaction.

According to the National Association of Realtors, one of the biggest misconceptions homebuyers have is about how much cash is required to buy a home. When surveyed, 35 percent of consumers thought they needed 16 to 20 percent of the purchase price as a down payment, while 10 percent thought they needed more than 20 percent. That’s what makes the concept of zero-down payment so enticing.

Keep in mind that while zero-down mortgages can help you into a home faster, you’ll also be responsible for 100 percent of the purchase price. You won’t have any equity built up in the house, as you’ll owe what it was purchased for. Growing equity can take years, depending on the current housing market. And if housing prices fall, you’ll still be responsible for the full amount of the home loan.

Zero-down mortgages also mean increased monthly payments. These loans typically come with higher interest rates to cover the additional risk lenders face in making the loan. Lenders also often require private mortgage insurance, also known as PMI, to protect their interests if you fail to repay the loan. This is usually required on all mortgage loans where the buyer puts down less than 20 percent of the purchase price. An Urban Institute report stated that PMI is typically between 0.58 percent to 1.86 percent of your mortgage.

Is a Subprime Mortgage Right for You?

Before you move forward with your home purchase dreams, the best place to start is pre-approval. Pre-approval can show you what kind of mortgage you’re eligible for, and whether you’re eligible at all. It also tells the seller and real estate agents that you’re ready to buy. It can give you an edge over other potential buyers and help you figure out how much you’ll be able to borrow.

Getting the process started is easy; all you’ll need are the following:

  • A driver’s license and Social Security number
  • Two months of bank statements
  • Two years of income history
  • W-2s for the last two years
  • Two most recent pay stubs
  • List of current debts

And that’s it! Then you’ll be able to use your pre-approval information to make better decisions about your future. And finally, get into the house of your dreams.

If you’re looking for a great lender with a lot of options, consider Solarity Credit Union, based in Washington state. They offer zero-down home loans that might be just right for you.