Definition of "What is a subprime mortgage?"

To understand what is a subprime mortgage, we need to talk about the subprime definition. Subprime means something that is not in the best conditions and, in this scenario, it refers to a subprime borrower; that is someone who has a complicated financial history and provides too much risk for the lender. These borrowers might have filed for bankruptcy in the last 5 years, defaulted two or more times in the recent past, might have a large pending debt and/or a low credit score – or even no established credit history at all. A subprime mortgage is the type of mortgage offered to that profile of borrower.

But so what; is this subprime mortgage just like regular mortgages? Is the subprime mortgage definition made just to separate bad borrowers from good borrowers?

No, to compensate potential losses from those customers who may run into trouble and default, subprime mortgages have a higher interest rate. Those loans are also usually easy on the way in but become burdensome on the way out – they take advantage of the fact that the person has no other option. Most subprime borrowers that manage to fix their situation try a second mortgage later on to try and soften the weight of the later payments.

Subprime mortgages played a big part in the financial crisis of 2008 when hedge funds noticed they could make a lot of money off the buying and selling of those mortgages. They would buy the mortgage from the Lender and manage it with the borrower and everything went well for them until housing prices started to decay lower than the mortgage itself. That took the refinancing possibility off the table – and you couldn’t sell the home either because there was no one buying – which lead to (too) many owners of these mortgage-backed securities trying to collect their insurance against the mortgage defaults, which, in turn, made it financially overwhelming to powerhouse insurance companies that almost went bankrupt, and so was set the scenario for the period that became known as “The Great Recession”.

image of a real estate dictionary page

Have a question or comment?

We're here to help.

*** Your email address will remain confidential.
 

 

Popular Mortgage Questions

Popular Mortgage Glossary Terms

The highest rate possible under an ARM contract; same as 'lifetime cap.' It is often expressed as a specified number of percentage points above the initial interest rate. ...

The process of determining whether a prospective borrower has the ability to repay a loan. Qualification Versus Approval: To be approved for a loan, a prospective borrower must ...

Advice on where to go to get a mortgage. A borrower can always select a loan provider by throwing a dart at the Yellow Pages. A referral is of value if it raises the probability of a ...

A contract provision that adjusts the payment on an ARM periodically to make it fully amortizing. ...

The option to convert an ARM to an FRM at some point during its life. ...

A documentation requirement where the applicant's assets are not disclosed. ...

A mortgage lender that sells all the loans it originates in the secondary market. ...

Rates and points quoted by loan providers. You cannot safely assume that mortgage price quotes are always timely, niche-adjusted, complete, or reliable. Timeliness: Most mortgage lenders ...

On an ARM, the assumption that the interest rate rises to the maximum extent permitted by the loan contract. ...