What is Subprime Lending?

October 1, 2008 · Posted in Finance 

With the current economic crisis the United States is experiencing, there is a lot of talk about subprime lending practices, with specific attention on subprime mortgage lending. The term is fairly new and has been promoted via its use in the media. It refers to lending that financial institutions do that carries more risk than A-paper lending. Subprime lending is also sometimes called B-paper, near prime, second chance lending, or nonprime, and usually carries much higher interest rates than other loans do.

Subprime lending practices are found within a variety of different credit situations, including home mortgages, credit cards and vehicle loans. Lending is considered subprime when it does not conform to Fannie Mae or Freddie Mac guidelines for loan issuance. A loan may not meet Fannie Mae and Freddie Mac guidelines for several reasons, like the credit status of the borrower, job and income history of the borrower, the ratio of income to mortgage payment. The term subprime can also be applied to bank loans taken for properties that can’t sell on the primary market, including such loans as can’t be given to certain people that are self-employed, or certain investment properties.

Due to the mounting economic crisis, our attention has been drawn to practices in subprime lending, which some consider to be predatory. Allegations include lenders targeting borrowers that did not understand exactly what they were signing up for, and lenders targeting borrowers that could not realistically meet the terms of their loans. A borrower with poor credit history may not meet the Fannie Mae or Freddie Mac guidelines and standards, and therefore feel as if a subprime loan is their only option, regardless of the prohibitive terms or costs that come with it – hence “second chance” as a moniker, alluding to the idea that you could redeem your credit score with this new loan. Unfortunately, subprime loans often leave much less room for any financial difficulties the borrower may experience in future, and this can lead to high rates of defaulting on payments and foreclosures on properties.

Supporters of subprime lending maintain that it is a good thing that allows people access to the market that may not otherwise qualify to have credit extended to them – but one must bear in mind that if you don’t qualify via conventional means, it’s likely for a good reason, and turning to a subprime loan with high rates puts your finances at even more risk should you become unable to make your payments, and can easily put you in way over your head.


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