The term "subprime lending" describes a specific lending market sector that makes loans to customers who may otherwise have difficulties obtaining financing.
Typically, subprime customers do not qualify for prime market rates because they have blemished (or limited) credit. Consequently, they are charged a higher interest rate and higher fees by lending institutions to compensate for the increased risk of default or foreclosure.
Subprime lenders are usually stand-alone companies and are not affiliated with prime lenders (who take little risk with their funds). There are a number of lenders in the subprime mortgage market who "play by the rules" and serve communities that may have been underserved by other lenders in the past. However, other lenders engage in abusive practices such as
- Equity stripping, which occurs when a loan is made based on the equity in a property rather than on a borrower's ability to repay the loan.
- Packing, which is the practice of adding credit insurance or other "extras" to increase the lender's profit on a loan.
- Flipping, which happens when a lender induces a borrower to repeatedly refinance a loan, often within a short time frame, charging high points and fees each time.
So how can this be a problem for existing homeowners who have already obtained financing from a reputable source? Tightening guidelines on subprime lending are affecting all aspects of the mortgage industry. This makes it more challenging for homeowners to convert from an adjustable rate loan to a fixed-rate one, or to pull equity from their properties. Some borrowers are locking in rates, only to find out that their loan program doesn't exist a few weeks later.
Here's how one visitor to Mortgage News Daily sized up the situation:
"I can't refinance. There's no equity in my property. The loan I need can't be offered. I can't sell without bringing money to the closing. I don't want foreclosure. How do I make it through this cycle?"
The bottom line: Obtaining a new or refinanced mortgage can be a life-changing financial decision. Subprime finance companies offer customers with low FICO scores a chance to re-establish their credit and eventually qualify for loan programs with more favorable rates and terms.
Whether you're looking to buy or refinance, be sure obtain multiple offers and consider getting a second opinion. Have a back-up plan in case your financing is delayed or denied, and don't wait until the last minute to apply.
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