Mortgage Refinancing - Subprime Mortgages

Few lenders will use the term "subprime" to describe you or your loan, because it's considered bad salesmanship. You might hear the word "non-prime" or, more likely, an adjective won't be used to describe the mortgage at all.

Generally, subprime mortgages are for borrowers with credit scores under 620. Someone who is habitually late in paying bills, and especially someone who falls behind on debts by 30 or 60 or 90 days or more, will suffer from a plummeting credit score. If it falls below 650, that consumer is in subprime territory.

Mortgages for people with excellent credit are somewhat of a commodity, with rates that don't vary much from lender to lender for equivalent loans. That's not the case with subprime mortgages. You might receive widely differing offers from different subprime lenders because they have different ways of weighing the risk of giving you a loan. For that reason, it's important to comparison-shop when your credit score is less than 650.

Subprime loans have higher rates than equivalent prime loans. Lenders consider many factors in a process called "risk-based pricing" when they come up with mortgage rates and terms. This makes it impossible to generalize about subprime rates. They are higher, but how much higher depends on factors such as credit score, percentage of the home’s value being refinanced and what types of delinquencies the borrower has in the recent past (from a mortgage lender's standpoint, late mortgage payments are worse than late credit card payments).

A subprime loan also is more likely to have a prepayment penalty, a balloon payment or both. A prepayment penalty is a fee assessed against the borrower for paying off the loan early—either because the borrower sells the house or refinances the high-rate loan. A mortgage with a balloon payment requires the borrower to pay off the entire outstanding amount in a lump sum after a certain period has passed, often five years. If the borrower can't pay the entire amount when the balloon payment is due, he/she has to refinance the loan or sell the house.

Researchers contend that prepayment penalties and balloon payments are associated with higher foreclosure rates. The subprime mortgage industry contends that borrowers get lower interest rates in exchange for prepayment penalties and balloon payments, but that point is debatable.

Subprime customers have to be on the lookout for predatory lenders who set out to cheat borrowers. These lenders are likely to tell the borrower that his/her credit score is lower than it really is.

Another predatory tactic is to pressure a homeowner to refinance the mortgage frequently, charging high closing fees each time and rolling the closing costs into the mortgage amount. That goes hand-in-hand with another predatory tactic: Issuing a loan regardless of the borrower's ability to repay it. When the borrower inevitably defaults, the predatory lender forecloses and sells the property.

An ethical mortgage lender doesn't want to foreclose on a property because foreclosure is a money-losing process. An ethical lender makes money by charging interest and loses money by foreclosing. A predatory lender, on the other hand, profits by repeatedly collecting closing fees, then seizing the house.

To defend yourself from predatory lenders, find your credit score before shopping for a mortgage, and ask people whom you trust for referrals to mortgage lenders. And comparison-shop by going to at least two mortgage brokers or lenders.