Subprime loans are offered at higher interest rates to individuals with lower credit scores, making them more expensive. Financial advisors suggest buying only if necessary, as interest rates can vary between lenders. Tougher criteria for subprime loans have led to fewer home sales and a stagnant real estate market.
The term subprime loan is somewhat confusing. Since sub means below, it would be reasonable to assume that a subprime loan is desirable since it is below the prime interest rate offered at any given time. In fact, the opposite is true. The subprime loan is offered above the prime rate, usually because a person’s credit rating is less than perfect and poses a greater risk that the lender will not be repaid. This means that the person pays more interest on the money borrowed instead of less.
Prime is considered the interest rate at which banks and other lenders will offer loans to customers with the best credit rating. Not all lenders may qualify for the best rates, and these rates will vary considerably depending on the market and the type of loan. A subprime loan can also vary considerably. In fact, most financial advisors suggest buying if you can only qualify for a subprime loan, since each lender may have different criteria for determining creditworthiness.
Some financial experts also advise against taking out a loan if you can only get one at a subprime rate, because you’ll ultimately pay more in interest than loans you can get at a prime rate. However, in some cases, it still makes sense to get a subprime loan if the money is really needed and there is no other way to pay off the debts. With the drop in home prices in some areas since 2006, some people who would have been considered for a subprime loan would not be able to obtain one.
Several lenders have focused on lending money at subprime rates to borrowers with less than perfect credit. The ideal for many of these borrowers, who bought homes in 2004-2005, was that real estate was booming and that within a few years of establishing creditworthiness, borrowers could refinance their homes at lower rates. Some took out interest-only loans with high risky rates, which meant they weren’t building equity in their homes.
Instead of the continued housing boom, there was a significant drop in home values in 2006 and 2007. Many people were unable to refinance their homes at a lower rate, and people with interest-only loans were left with payments greater than they could afford, and houses that were actually worth less than they were at the time of purchase. The subprime rate didn’t help much and many people were forced to sell their homes or default on their loans. This situation has caused concern among lenders whose main clients are those with subprime loans. A large number of loan defaults due to an inability to make high payments has resulted in lenders with less money to lend and less profit.
In 2007, some lenders instituted tougher criteria for obtaining a subprime loan and also increased the interest rates at which money can be borrowed. This translates into fewer home sales, a continued drop in retail home values, and a stagnant real estate market. On the other hand, making it harder to get a subprime loan can save some people money and create incentives for them to increase their credit scores.
Smart Asset.
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