Subprime home loans are typically reserved for borrowers with a credit score below 620, as that is the conventional loan threshold. These loans hold a different meaning for borrowers; however, because they offer borrowers with derogatory credit with the ability to obtain a loan. It is important to note, however, that they pay a much higher interest rate than a conventional borrower would pay. This is a Catch 22 for many borrowers because they have poor credit because they could not keep up with their other payments. Having a higher interest rate makes them more likely to default, but it is the way that the banks make up the risk that they take by providing the loan to them.
Risk Based Pricing based on Credit Score and Past Credit History
Something to understand when you are taking on a subprime loan is the type of pricing you will receive. Your interest rate will directly correlate with your credit score. The lower the score, the higher your interest rate and vice versa. In addition to your credit score, however, are the actual trade lines shown on the report and what they are reporting. The number of delinquencies you have in the last 12 months; whether or not you had a foreclosure/bankruptcy; and the number of outstanding collections reporting all have an impact on the pricing of your loan. Something to remember is that lenders look closely at your housing history, whether you pay a mortgage or you rent. If you have a string of delinquencies on your housing payments in the last 1 to 2 years, it will negatively impact the rate you are provided because you are considered a higher risk than someone that may have had a few late payments on their revolving credit as opposed to their housing payments.
Signs you Need a Subprime Loan
Your credit score is the largest indicator determining whether or not you need a subprime loan. Typically, if your score is below 620, your only option is a subprime loan, with the exception of the FHA loan. Many lenders will allow an FHA loan to have a minimum score of 580 as long as there are other compensating factors in place for the loan. For example, if you have a debt ratio that is considered low (below 36%) and a 590 credit score, a lender might be willing to provide you with an FHA loan as opposed to a subprime loan, allowing you to save money on interest. You will have to pay mortgage insurance on a monthly basis as well as upfront mortgage insurance fees; however, so you will have to weigh the pros and cons between the two loans to determine which is right for you.
Aside from your credit score, there are other determining factors when it comes to determining if you need a subprime loan. A large indicator is any delinquencies you have in your housing history, particularly over the last year. If you have more than two 30-day late payments, you will be ineligible for FHA or conventional financing. The same is true if you have one payment in your housing history over the last 12 months that was 60-days late. Other situations that limit your options to a subprime loan include a foreclosure that took place in the last two years or a bankruptcy that has not been discharged for a full 24 months. These are all automatic turndowns for conventional and FHA financing, making subprime lending your only option.
The New Subprime Loans
If you find that you are only eligible for a subprime loan, don’t think that you are stuck with ridiculously high interest rates and unpleasant terms. The subprime loans of 2015 have to meet the requirements of the Ability to Repay Rule. This rule makes lenders follow certain guidelines so that borrowers are not stuck with a mortgage that they cannot afford. What it means is that subprime loans no longer mean stated income; stated asset; or no document loans. Everything today needs to be documented whether or not the loan is being sold to anyone. Even lenders that keep the loans on their books, which most lenders do for subprime loans, have to abide by the Ability to Repay.
Now, not only do lenders have to determine if a borrower truly can afford the loan by fully evaluating their income, assets, employment, debt ratio, and credit score – lenders need to keep their fees, interest rates, and terms in line. Yes, you will still pay a higher interest rate – that is a tradeoff for taking on the risk of your loan. What lenders cannot do is provide you with any unnecessary terms, such as negative amortization, interest only payments, balloon payments, or any type of excessive fees.
Subprime loans today basically mean that you have a lower than average credit score, which for some lenders might mean below 620, while for others it might mean lower than 680. It just depends on the lender and what type of risk they are willing to take. It also means that you still have to prove certain factors, such as the need to show adequate assets to prove you can afford the loan and have reserves in the event that you need them; you have a low debt ratio; you can put down a large down payment; or you have a stable income/employment history.
No lender is going to just hand out a mortgage to hand it out. The mortgage crisis has taken that away from us. What they are going to do is operate due diligence in determining what you can afford and how likely you are to continue to make your payments. If the lender cannot prove beyond a reasonable doubt that you can repay the mortgage, no matter how high or low your credit score may be, you will not get the loan. Keep your credit score in mind when you are applying for a subprime loan, but do not forget about the other factors that will play a role in your approval or denial.