'Sub-prime Borrower' is explained in detail and with examples in the Real Estate edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
A sub-prime borrower is an individual who has credit that is considered to be less than perfect. This is the opposite of a prime borrower. Bankers call prime borrowers those who possess higher and better credit scores, low debt ratios, and significant incomes which are more than enough to cover their monthly bills and expenses.
Sub-prime borrowers often are only able to obtain sub-prime loans. These types of loans received the blame for causing the 2008 mortgage crisis. Despite this fact, the loans continue to exist today. They are an important part of post crisis lending, though so far they have not caused another financial crisis or global meltdown.
Those called sub-prime borrowers have many characteristics in common. These imply that the individuals are more likely to default on their mortgage loans than other individuals. Poor credit is the first element they share. This could be because they did not receive any opportunities to create a sufficient credit history.
It might also be from problems they had with making payments in the past. The dilemma for these borrowers is that they do not have many choices other than sub-prime lenders. This often traps them in a cycle of debt from which is difficult to escape. An under 640 credit score is considered to be sub-prime, though some lenders set the defining limit lower to even 580.
The sub-prime borrowers also have problems with their monthly payments. These payments are so large that they consume a significant part of the monthly income for the borrowers. This is determined in how high the debt to income ratio proves to be. A higher DTI ratio means that the borrowers do not have enough money to cover bills if they suffer a drop in income or have unanticipated expenses arise. Loans can still be approved in some scenarios when the borrowers’ present debt load is significant.
The cost for a sub-prime loan is another thing these borrowers share together. These forms of mortgage loans usually cost more since lenders do not want to assume additional risk without higher compensation. Predatory lenders have used this limited ability to receive loan approvals in order to prey on borrowers with no other choices. These higher expenses manifest in a few different ways. It might be junk application and processing fees, greater interest rates, and penalties for early prepayment which prime borrowers seldom pay.
Risk is the dominant theme for sub-prime borrowers, lenders, and loans. Because the loans have a lower chance of being paid back, the lenders exact more in fees and higher rates. These greater costs cause the loans to be riskier for the borrowers as well. Debt is difficult to retire when higher interest rates and costs come with it.
Sub-prime borrowers should try to avoid these expensive and debt trapping loans whenever they can. Staying out of such costly credit is essential for individuals to not drown in debt. This is easier said than done when people are put into the sub-prime category. There are not as many options to comparison shop for the loans. There are also fewer options for alternative kinds of loans to use for the needed financing.
If these borrowers are able to make themselves look less risky to the various lenders, it will improve their chances of escaping from these types of loans. This may mean some credit repair work needs to be done before individuals with credit challenges make applications for loans.