By: Scott B. Riddle, Esq.
It appears as though the term "sub-prime mortgage" is going to be thrown around quite a bit in the near future, especially in the Bankruptcy context. Two of the largest sub-prime lenders are now in Bankruptcy. New Century has filed a Chapter 11 and is still operating, at least as of today. Atlanta based SouthStar has closed and is liquidating in a Chapter 7.
So, what exactly is a "sub-prime mortgage?"
Here is one definition —
A sub-prime lender is one who lends to borrowers who do not qualify for loans from mainstream lenders. Some are independent, but increasingly they are affiliates of mainstream lenders operating under different names.
Sub-prime lenders seldom if ever identify themselves as such. The only clear giveaway is their prices, which are uniformly higher than those quoted by mainstream lenders. You do want to avoid them if you can qualify for mainstream financing, and I’ll indicate how shortly.
There are lenders who offer both prime and sub-prime loans, and one of them is referred to below. For borrowers who aren’t sure where they stand, dealing with a lender who offers both has a distinct advantage. They will try to qualify you for prime and only if that fails will they drop you to subprime. Lenders who are strictly subprime might refer a prime borrower to an affiliated prime lender, but their financial interest dictates otherwise.
Wikipedia provides the following entry –
Subprime lending (also: B-Paper, B-tier, non-prime, near-prime, special finance, second chance lending) describes loans to customers having a credit score below 620, although there is no official definition — others consider subprime loans to borrowers with credit scores below 650 or 660, for example.
Typically, subprime customers are those who do not qualify for prime market rates because of a low credit score. Subprime loans are considered more risky, and generally have a higher rate of default than prime borrowers. Subprime lending programs were created for borrowers unable to qualify for loans under traditional, more stringent criteria. Subprime borrowers tend to pay more for the loans to compensate for the increased probability of future default. This charge may come in the form of a higher interest rate, regularly charged fees, or an up-front fee.
According to the 2001 Expanded Guidance for Subprime Lending Programs, a subprime loan refers to "… the credit characteristics of individual borrowers. Subprime borrowers typically have weakened credit histories that include payment delinquencies, and possibly more severe problems such as charge-offs, judgments, and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios, or other criteria that may encompass borrowers with incomplete credit histories. Subprime loans are loans to borrowers displaying one or more of these characteristics at the time of origination or purchase. Such loans have a higher risk of default than loans to prime borrowers."