A sub-prime mortgage is one where the home loan that the bank or lending institution makes is offered to the category of consumers who are considered to possess the riskiest credit. Sub prime mortgages are actually sold on a different market than are prime mortgage loans. Sub prime mortgage borrowers are determined through a combination of factors, such as the credit rating of the borrower, the documentation offered for the loans, and the borrower’s debt to assets ratio. Besides this, sub-prime mortgage are also deemed to be those that do not fulfill the prime mortgages’ standards and guide lines offered by Fannie Mae and Freddie Mac, the two biggest issuers of mortgages within the United States.
A universally agreed upon definition for sub-prime mortgages does not exist today. In the U.S., sub-prime mortgages are commonly considered to be those where the associated borrower possesses a FICO credit rating score that is less than 640. This phrase became a part of pop culture in the credit crunch that occurred in 2007.
The original sub-prime mortgage program began in 1993. At this time, some lenders started offering sub-prime mortgages to borrowers classified as high risk, who possessed credit that was less than ideal. Traditional lenders showed wariness towards sub-prime mortgages and borrowers. They tended to shy away from people who had impaired credit histories. Sub-prime mortgage borrowers commonly have information on their credit reports that argue for greater percentages of defaults. These include too much debt, a track record of not paying debts or missing payments, recorded bankruptcies, and low amounts of experience with debt.
Around twenty-five percent of the American population is grouped into this category of sub-prime borrowers who qualify for the category of sub-prime mortgages. Because of this, proponents of sub-prime mortgages argued that they allowed a large number of people to gain access to credit who would not otherwise have experienced the opportunity to purchase and own a home. Borrowers with less than perfect credit who can demonstrate enough income are able to qualify for sub-prime mortgages. This proves to be the case even if their credit scores are lower than 640.
The lenders who participate in sub-prime mortgages take significant risks in so doing. This is because people who have a credit score of less than 620 statistically possess a significantly greater rate of defaulting on their mortgages than do those people with much higher scores over 720. Lenders compensate for the risks associated with offering sub-prime mortgages through several different means. One of these is by charging higher rates of interest. They also collect late fees for any customers who do not keep up with their payments. These greater interest rates and fees help to reward lenders who take the risks of the higher default rates, and who also incur costs for collecting and keeping up with these -mortgage accounts. As an example of their potential danger, sub-prime mortgages proved to be among the main causes of the Financial Crisis of 2007-2010.