The Unique Real Estate Blog

What is a Subprime Mortgage?

While the word ‘prime’ normally refers to the base interest rate charged by major lenders across the country, a subprime mortgage refers to a home loan offered to a borrower that is higher risk than normal, not a lower interest rate.

Quite to the contrary, customers who have poor credit scores, low income, or other risk factors which make them candidates for a subprime mortgage will typically pay much higher than prime rates; though lenders will often offer an introductory ‘teaser’ rate which is comparable (or lower than) prime to get their foot in the door.

Of course, introductory rates are only temporary; and after a year or two they expire and the interest rate on a subprime mortgage go up. Those with fixed rate mortgages may know what to expect, but a large percentage of subprime borrowers with adjustable rate mortgages are at the whim of the market.

Those with subprime ARM’s normally pay the prime rate plus additional percentage points (how much extra depends on their loan particulars), which has resulted in many borrowers who once had introductory rates as low as 4 or 5% now facing interest rates in the double digits.

Subprime Mortgages and Declining Property Values:

Many subprime borrowers have traditionally offset the increased interest rates that kick in after their introductory period ends by refinancing their homes or taking out a second mortgage.

The ability to do so however revolves around the concept that property values are constantly increasing, as they traditionally do and had been quite steadily for some time. With property values actually having declined over the last year however, many homeowners simply aren’t able to secure additional finances using these methods anymore.

When High Interest Rates and Lowering Property Values Collide:

With high interest rates increasing homeowners monthly mortgage payments and lower property values making it difficult; if not impossible, to secure additional financing in order to make those payments, many people simply don’t have the means to keep them up anymore.

And that’s why we’re seeing a record number of homeowners defaulting on their loans these days, and a record number of foreclosures following. And unfortunately, with subprime mortgages accounting for nearly 20 percent of the market in 2006, there are likely lots more to follow.

Is Anything Being Done About It?

In an attempt to slow the tide of foreclosures, a number of proposals have been made for government funded bailout plans. The majority of these proposals involve fixing interest rates for an additional period of time or helping homeowners refinance at a better rate, but of course; government intervention means taxpayer funding, which has upset plenty of Americans in the process.

Matthew is a contributor to The Mortgage Miser, a resource for prospective home buyers providing guides, mortgage calculators and other related help and information.