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Not all borrowers qualify for a regular or "prime" mortgage loan, often due to having poor credit. If a lender considers you to have a greater risk of default than other borrowers, you might only qualify for what is known as a subprime mortgage.
Because of their role in the 2008-2009 financial crisis, subprime mortgages have a bad reputation. If you're thinking about getting one, it's important to understand the risks.
A subprime mortgage is a type of mortgage offered to borrowers with low credit scores or other credit issues. Because a subprime borrower is seen as a greater risk of not paying off their loan, they are required to pay a higher interest rate.
Because of this, these mortgages can be significantly more expensive than traditional conventional mortgages.
Note: Each lender determines their own definition of subprime status. Additionally, some may use different or more finely-tuned terms such as non-prime, near prime, or deep subprime.
Subprime mortgages are perhaps best known for their role in helping to create the housing bubble that led to the financial crisis of 2008-2009 and the Great Recession of 2007-2009. When the bubble burst many homeowners found themselves "underwater" with mortgage balances greater than the value of their homes.
Because of their role in the financial crisis, subprime mortgages have a negative connotation. Lenders have begun using the term "non-prime mortgage." The main difference between the two is that non-prime mortgages are subject to tougher, more responsible underwriting.
This allows people who can demonstrate their ability to keep up with house payments, but who have suffered a recent financial loss or tragedy, the opportunity to own their own home.
See Insider's picks for the top low credit score mortgage lenders>>
Although there is no one-size-fits-all number, generally speaking, borrowers with FICO credit scores in the low 600s and below are considered subprime. The Consumer Financial Protection Bureau considers scores below 620 to be subprime, while the credit reporting agency Experian says that scores below 670 could fit into this category by some lenders' definitions.
Because they don't conform to typical mortgage standards, subprime or non-prime mortgages can come with a variety of different terms, rate structures, and requirements.
Although you will pay a higher interest rate with a subprime loan, the sky is not the limit. The government caps interest rates on subprime mortgage loans and lenders have to honor those caps.
Quick tip: You can use Personal Finance Insider's mortgage calculator to see how different interest rates would affect your monthly payment.
Often, subprime mortgages are adjustable-rate mortgages, meaning you'll start with a rate that stays the same for a set amount of time then adjusts periodically depending on current market rates. But you can also find subprime mortgages that come with fixed rates, where your rate stays the same for the entire term.
You may be able to find subprime mortgages that spread out your payments over an even longer term than the typical 30 years, like a 40-year mortgage. Or the loan might be set up as an interest-only mortgage, where you only pay the interest each month for a set period of time. This type of setup can be risky and expensive.
Just because you can get a subprime loan doesn't mean you should. If you don't qualify for a prime mortgage now, the best thing to do is work on rebuilding your credit, paying off debt, and saving for a higher down payment.
If your situation has improved and you're financially stable enough to handle a mortgage payment but can't yet qualify for a prime loan, you might decide that getting one of these mortgages makes sense for you.
Some of the factors that have a negative impact on a borrower's FICO credit score leading to subprime status are:
"Often, consumers don't comprehend the risks of the financial products they're signing themselves up for," says Jeffrey Zhou, CEO of Fig Loans.
Subprime mortgages may not come with the same affordable features that you'll find with prime mortgages.
The mortgage rate you'll get with a subprime loan is dependent on four factors: credit score, the size of your down payment, the number of late payment delinquencies on your credit report, and the types of delinquencies found on the report. These rates are often significantly higher than prime mortgage rates.
If you're still experiencing the hardship that caused your credit score to fall, or if you haven't addressed underlying money management issues, getting a mortgage may only make your situation worse.
Ultimately, a subprime or non-prime mortgage loan costs more, both in the short-term and in the long-term. This can increase your risk of defaulting on the loan and losing your home to foreclosure.
If the issues that led to your poor credit are now resolved and you're confident you can keep up with your monthly payments, there can be benefits to becoming a homeowner now versus waiting until your credit has recovered.
Once you buy a home, you start building equity. Home values tend to increase over time, so the sooner you get into a home, the more time you'll have to benefit from that.
A monthly mortgage payment gives you the opportunity to build back your credit. Over time, your credit score should improve as you build a history of on-time payments.
However, if you end up unable to make your payments, your credit will become even more damaged.
Before you get into a subprime loan, consider the alternatives.
"Don't think that you're choiceless," says Zhou. "There are other and even better options than settling for a subprime mortgage. You can qualify for a homeownership assistance program if you don't meet the credit requirement. So don't lose your hope of owning a home."
Subprime mortgages aren't for everyone. If you're not in a rush for housing, it's probably better to improve your credit and qualify with a mortgage lender that offers prime loans. If you don't have time to wait, look into one of the alternatives listed above.
Check with trusted local banks and mortgage lenders who offer prime rate mortgage loans. Many traditional lenders also offer subprime (non-prime, if you prefer) mortgage loans. Read customer reviews and look at the lender's rating from the Better Business Bureau to gauge how reputable the company is.
Consider lenders that offer non-QM mortgage loans, such as Angel Oak or Carrington. A quick online search using terms such as "subprime, non-prime," or "non-QM" mortgage loans should yield results.
You might find it helpful to talk to a Department of Housing and Urban Development-sponsored housing counseling agency. You can search on HUD's website for an agency in your area. They can help you understand what mortgage options might be available to you, and what you can do to improve your credit for homeownership.
If you get a subprime mortgage, your goal should ultimately be to transition from a subprime mortgage to a prime mortgage. This means improving your creditworthiness and then refinancing into a prime mortgage.
What qualifies you for a subprime mortgage? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
Subprime mortgages are available to borrowers with lower credit scores, such as those in the low 600s or below.
Are subprime mortgages still available after the financial crisis? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
Yes, you can still get a subprime mortgage today, but they typically require stricter underwriting to ensure that the borrower can afford to repay the loan based on their finances.
How can I improve my chances of moving from a subprime to a prime mortgage? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
The best way to improve your chances of qualifying for a prime mortgage is to increase your credit score. You can do this by making on-time debt payments and keeping your credit utilization low.
What are the typical interest rates for subprime mortgages? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
Subprime mortgages have higher interest rates compared to prime mortgages, since they're riskier for the lender.
Can a subprime mortgage help me build my credit? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
As long as you stay on top of your payments, a subprime mortgage should help you rebuild your credit over time.
What is an example of a subprime mortgage? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
The exact definition of what type of credit is considered subprime varies from lender to lender. For example, if a lender typically won't lend to borrowers with scores below 660 but it has a loan product with higher interest rates for borrowers with scores down to 580, that would be considered a subprime mortgage.
What are subprime mortgages called now? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
You may sometimes see subprime mortgages referred to as non-prime. They may also fall under the umbrella of non-QM loans, which are those that don't meet qualified mortgage standards set by Consumer Financial Protection Bureau.
