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What is a sub-prime mortgage?
It looks like some mortgage companies are having trouble and they keep referring to sub-prime mortgages on the news. Exactly what is a sub-prime mortgage? Are they all bad?
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 "Sub-prime" simply means that the mortgage loan was made to someone with less than excellent credit, or without some of the traditional underwriting steps normally used for residential mortgage lending. For example, if the standard residential mortgage is approved for applicants with credit scores greater than "X," a lender making sub-prime loans might make a mortgage loan to someone with a lower credit score (which suggests there is more credit risk involved), but at an interest rate that's higher than the lender could get for a loan with applicants with excellent credit.
Some lenders make "low documentation" or "low-doc" mortgage loans for which the applicant's income isn't verified. These loans command a higher interest rate, too, because of perceived greater credit risk.
Some lenders were tempted to lower their credit standards even more in order to continue making loans (at higher rates of interest). In some cases, these loans were made as adjustable rate loans with deeply discounted introductory rates, just to get the loans booked.
Not all sub-prime loans have resulted in defaults, any more than all "prime" loans have experienced perfect payment histories, but even the sub-prime loans have different levels of credit risk, with those with deeply discounted front-end rates being at great risk as the first rate adjustment dates come around and payment amounts are greatly increased (often so much as to make the borrower unable to make the payments). There is no doubt that sub-prime mortgage loans are under great scrutiny, and most of the investors who used to pump money into these loans by purchasing them from lenders have taken their money to safety, making the sub-prime industry very weak, and unable to make loans. That means that homebuyers are finding it more difficult to find mortgage financing, particularly for very low downpayments or marginal income situations.
Published on BankingQuestions.com 8/17/07
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