By ‘sub-prime loan’ we understand a type of loan that has a higher interest rate as compared to a prime loan. This type of loan is generally approved for people with limited or poor credit history. A higher interest rate is attached to sub-prime loans for giving necessary coverage to the risks involved on the part of lenders to the ‘risky’ borrowers with bad credit records.
Because of the associated risks to provide loans to people with poor credit history, not all the lenders offer sub-prime loan programs. The mark of distinction between a prime and sub-prime lender is the higher interest rates charged by the latter. You should always opt for a prime loan instead of a sub-prime as long as your credit report permits. Avoiding sub-prime loans as far as possible is always beneficial for borrowers.
A sub-prime borrower is one who does not qualify for prime loans usually due to a low credit score. This score that we are talking about is normally referred to as the FICO Score. Lenders use this score to determine the eligibility of loans by the borrowers. A mid-range FICO score enables the borrower for applying (and being approved) for a loan with some factors taken into account. Such factors could include your concurrence to the proposed down payment amount, your outstanding debts and your ability to document the income. It is evident that many potential sub-prime borrowers may not be in a position to document their income being self-employed. In such cases, borrowers apply for what is known as ‘stated income loan’. A stated income loan is one where the borrower states or declares his income in the loan application form. Due to the inability of assessing or verifying such incomes, a further higher interest rate is charged to these stated income borrowers when sanctioning the loan.
While determining the interest rate of sub-prime loans, the same factors of prime loans are taken into considerations. If your credit score is low and you opt for a lower down payment amount, your interest rates will inevitably be higher. Also keep in mind that sub-prime lenders charge higher rates and higher associated fees due to the risks they undertake and higher costs they incur. It is also a common phenomenon that sub-prime loans end up in default more than prime loans.
Prime Borrowers Switching to Sub-prime – When and How
It is very interesting to note that many potential prime borrowers ultimately end up as a sub-prime borrower. Despite having good credit score, proper documented income and ability to comply with higher down payment amount; these people get entangled with sub-prime payments. This occurs due to those illusive TV or radio commercials which brag about attractive deals in financing or refinancing your mortgage. They offer you cash deals that are supposedly enough to clear your mortgage dues and lower monthly payments by cutting interest rates. But be advised that these so called ‘unbelievable deals’ expire early leaving you paying higher prices for your home.
If you are exploring the market for your options to finance or re-finance your home, you need to double check all the details before making a final decision for a loan. TV and radio are for your information and entertainment; hence you should be very careful with experimenting media deals that may dry-up your wallet. Always check for options with renowned lenders if they can approve a prime loan instead of sub-prime.
Do you know that a report by Wall Street Journal found that 61% of all borrowers ended up with sub-prime loans were eligible for a prime loan? This finding alone explains all about the ignorance of potential prime borrowers.
Sub-prime loans are designed to allow access to credit market by people with poor or no-credit status. You may be surprised by the endless prospects by sub-prime lenders but you should also be prepared to handle surprises of higher payments and bigger losses.