Subprime lending is becoming an option for many homeowners once more several years after an overflow of subprime loans brought the housing market to its knees.
Shortly after the financial crisis in 2008, subprime lending became synonymous with risk and foreclosure. Too many people simply couldn’t afford to keep paying their mortgages as they lost their jobs and the interest rates on their home loans increased.
Banks quickly abandoned these types of loans and tougher underwriting standards began to be put in place with the passage of the Dodd-Frank bill. But as of 2013 and well into this year, a number of banks are beginning to offer subprime loans once more.
What are subprime loans?
A subprime loan is a loan with an interest rate above prime rates for borrowers who are unable to qualify for prime rate mortgages. Subprime borrowers typically don’t have the best credit score and thus pay a premium to be able to borrow. They are statistically more likely than other borrowers to default on their loans.
When it comes to buying a house, a subprime loan can costs tens of thousands of dollars more than a conventional loan in interest payments. They are often used as a last resort after the borrower has tried and failed to qualify for loans that come with better terms.
Subprime loans that are being offered today
Only a handful of banks are currently offering borrowers subprime loans. Those that are offering these types of loans are attaching 8-13% interest rates with them as opposed to the 4% interest rates that borrowers can get with a 30-year fixed rate mortgage.
As underwriting standards have gotten less restrictive borrowers who have gone through financial hardship are finding it easier to qualify for subprime loans. However, these borrowers will have to pay a premium in order to compensate for the riskier nature of their loan. In most conventional loans, the borrower will end up putting somewhere around 10% down. For an FHA loan, the borrower may be able to still purchase a home with as little as 3-4% down.
The borrowers in today’s market who find that subprime loans are their only option will often end up putting at least 35% down. This has given them a rather limited appeal as many buyers simply decide to improve their financial standing than take out a loan with such a high down payment and interest rate.
Some housing market analysts have argued that subprime loans will likely continue to play a more important role as time goes on. It has been estimated that after the financial crisis, around 12.5 million people were shut out of the housing market who previously might have qualified for a home loan. Minority groups have been hit especially hard as the new regulations have made it more difficult to qualify for a loan. Easing these buyers back into the market could give new life to a housing market that’s had many ups and downs over the last several years.