If you aspire to own a house and consider getting it through a loan, the creditor will review your credit standing and financial health status to assess the degree of threat as a debtor. Being eligible for a mortgage will depend on what the evaluation will disclose. And if the borrower has a poor credit history that interferes with the dream of buying a property, subprime loans could be a good choice.
However, subprime loans are intended for the most at-risk borrowers since they appear expensive. So before considering obtaining one, understand what subprime mortgages are all about.
Subprime mortgages, also called non-prime mortgages, are a type of house loan intended for being promoted to debtors with bad credit history and lesser credit scores, usually lower than 600, which prohibits the borrowers from being accepted to traditional mortgages. This kind of mortgage includes greater interest rates and more significant initial payments. It is accessible to borrowers with poor credit standing that offers them a way to purchase a house, however, with significant risk.
Subprime loans do not pertain to the interest rates frequently associated with loans, but instead, it pertains to the credit score standing of the borrower getting ready for the said mortgage.
Creditors will classify subprime borrowers as those with credit scores of 670 and below. However, this threshold in the credit score might differ from one company to another. Other creditors or financial institutions might estimate the borrower's economic competence by their earnings and other liabilities and can also be utilized to evaluate the borrower’s creditworthiness.
If there is anything at all that creditors do come to an understanding is that the applicants for the subprime mortgages are highly likely to default payments or be delinquent on their mortgage as compared to applicants with a good credit standing. And since the subprime applicants are perceived to have a higher risk in paying off, the creditor usually costs them more outstanding charges and interest rates.
Subprime mortgages are controlled by the CFPB (Consumer Financial Protection Bureau), the agency established as a component of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was ordained to address the subprime crisis during the past years. Among the primary regulations of the CFPB is the condition that any borrower who acquires subprime loans needs to go through counseling with a delegate sanctioned by HUD (U.S. Department of Housing and Urban Development).
Furthermore, creditors should underwrite subprime loans based on the Dodd-Frank criteria, containing the stipulation of an ATR of the “ability-to-repay," which mandates a creditor to evaluate if the borrower can repay the mortgage carefully. Creditors are liable to governing execution if found to violate the ATR stipulation.
Below are the four (4) kinds of non-traditional subprime loans that borrowers might bump into if their credit score is lower than the ideal:
Subprime ARMS or Adjustable-rate mortgage
This is the most general subprime home mortgage that usually begins with a lesser rate before changing to a fluctuating rate. The change can upsurge the payment considerably every month, hurting and accumulating substantial uncertainty in every home’s financial plan. For this reason, it will add to the somewhat high defaulter rates, which is usual for subprime mortgages.
Longer term mortgages
This kind of mortgage is linked to traditional loans with payback terms of 40 to 50 years rather than the usual 30-year term. More extended periods will make your monthly payment lesser, but remember that repaying for a longer term can amount to paying much more during the loan duration.
In this interest-only mortgage, the applicant has a choice, during the first phase of the payoff cycle, which is usually 3 to 10 years, to settle merely the interest payable on the mortgage minus paying off the principal.
Subprime fixed-rate mortgages
Subprime fixed-rate mortgages mean that the potential borrower obtains a fixed interest rate which monthly payment stays unchanged for the mortgage payoff term.
Getting subprime loans is one of many borrowers' choices if they have a poor credit score. Before applying for one, consider the other mortgages that can help borrowers with lesser credit scores or earnings.
The FHA mortgage is a loan protected by the Federal Housing Administration, whose requirements are more straightforward and less complicated. When the borrowers have a credit score of no less than 580, an FHA mortgage might be a good choice with a 3.5% down payment, while a 10% down payment for a credit score of 500 to 579.
The VA loan is a mortgage supported by the government and provided by the U.S. Department of Veterans Affairs solely for active military members and Veterans to buy or refinance a house. The VA loans do not need an initial payment and could require a lesser credit score.
The U.S. Department of Agriculture (USDA) back up this kind of mortgage, intended for applicants with low to moderate wages in rural chosen regions. This mortgage does not require the borrowers to make an initial payment to be eligible. The credit score is only the lowest because it intends to pursue potential homeowners with restricted earnings in buying a house.
One good option is to wait, hold back and sit tight while settling your dues on the dot, and concentrate on the essential need to expand your credit scores.
Subprime mortgages offer a chance to potential borrowers with limited choices. Below are some of the advantages of subprime loans:
The opportunity of owning a home.
Subprime loans provide borrowers who have lesser credit scores the chance to purchase a house of their own beyond devoting time to making an effort to establish or restore their credit scores.
Increases your credit score.
Creating on-the-dot, consistent payments on your loan will establish an optimistic payment history, an essential aspect of credit counting.
Interest rates limit.
Thankfully, the federal government has policies that determine limitations on the interest rates for subprime loans, and the creditor is obliged to conform to those regulations.
Though there are opportunities for subprime loans, there are also downsides associated with this kind of mortgage.
Interest rates are higher.
To counterbalance the risk to borrowers with poor credit scores, creditors require higher interest rates on the mortgage approval, usually ranging from 8 to 10 percent.
Higher upfront costs.
Along with the higher interest rates, upfront cost entails higher costs such as the initial payment, closing charges, and other fees associated with subprime loans. Some creditors may oblige an initial amount as high as 35% to obtain higher upfront costs that compensate for the risk of default payments from borrowers with poor credit scores.
Extra costly both short and long term.
Considering the higher interest and upfront costs associated with subprime loans, the borrower will face the difficulties of a bigger monthly payoff. More so, if the loan duration is more prolonged, say 50 years, the borrower will finish off by repaying a significant amount until the completion of the mortgage.
Subprime mortgages may be flawed because of their higher interest rates and upfront costs. But for people with a strong desire to own their dream house but with poor credit scores, and if the subprime loan is the only option for homeownership, it may be worthwhile.
However, if the borrower is ready to become a homeowner, it would be best to postpone and devote time to improving their credit scores and financial health status. Talk to an expert or look for a reputable company to guide you in exploring your best options on the mortgages you may qualify for in buying that dream house.