Subprime Loans: What Are They?

     Subprime loans are the types of loans, lines of credit, and mortgages that are extended to those with imperfect and poor credit. Subprime lending is usually for those who have issues with meeting the repayment schedule. People with medical emergencies, unemployment, and divorce are usually good candidates for subprime loans. Subprime lending is also known for having higher interest rates, and can be considered a risk for both the lender and the borrower. According to Investopedia (2015), “A large amount of risk is associated with subprime mortgages. Since the mortgages are specifically for people who do not fit the requirements for a prime mortgage (which usually means the borrower will have a difficult time paying it back), the organization or bank lending the money has the right to charge high interest rates to provide an added incentive for the borrower to pay on time”. Subprime loans are usually for those with credit ratings below 600. The candidates for subprime loans are placed in a higher position to default on what they have received, because they had a poor history of being able to make repayments in the first place. They also had higher interest rates to pay, which just means that there’s more being added to the loan. People with poor credit rarely have the opportunity to be approved for traditional home mortgages and conventional loans.

     Take a look at this video that explains the difference between prime and subprime loans. Courtesy of Brian O'Connor, personal finance columnist for The Detroit News: See Here

      Now that we understand some of the risks of subprime loans for borrowers, lets go over some of the risks of subprime loans for lenders. A very large risk for lenders, who participate in providing credit to borrowers, is the risk of the borrower defaulting on the loan. Lenders already seem to have an idea of what a potentially high-risk borrower looks like. According to Neil Librock (2015), “Credit scores predict the statistical odds of that a customer will default. The median consumer FICO score of about 720 has a projected default risk of about 6%, while a "superprime" 780 score has a less than 1% default rate and a subprime 640 score has a 15% default rate, according to data from a 2012 study by the Consumer Financial Protection Bureau”. But, lenders always have the ability to write-off their losses, and also sell them to debt collectors.