Subprime lending is offering financing to an individual who won’t qualify for a conventional loan, on account of having a thin credit profile. Not too long ago, subprime lending suffered from a bad reputation. The housing market experienced steady growth from 1995 to 1999. With the stock market crashing a year later, monies shifted from Wall Street to real estate. This phenomenon led to financial innovation which included all sorts of lending products – interest adjustable loans, interest only loans, zero down loans. Banks were only too willing to offer these so the borrowers weren’t scrutinized in the way they are today. As a result, subprime loans increased to 292% between 2003 and 2007.
Then the housing market crashed in 2007. Many subprime loans went into default. Events at the time were so severe that America was in danger of finding itself back in the Great Depression.
Nearly a decade after, the economic is slowly finding its foothold. Subprime lending is back, but there are those who are wary of its renewed popularity.
This article will attempt to explain what subprime lending really is and why it remains relevant to this day.
Everyone knows that a high credit score and a solid, well documented financial background are crucial requirements to securing a loan. Unfortunately, many people do not possess these. Many Americans are working through debts or hold down three, even four different jobs at once. Circumstances like this make it difficult for them to get financing.
The earliest adopters of subprime lending realized the demand for homeownership amongst those with imperfect credit. They saw an opportunity to cater to this specific market segment.
Why It Still Works
- Rising property values are allowing subprime borrowers to gain equity in their homes, despite paying less than the fully amortized payment.
- This phenomenon, along with the Frank-Dodd Act, reduced lenders’ exposure to risk.
- Subprime loan administrators are implementing a more stringent qualification criteria for subprime borrowers. Lenders are also adding their own specific guidelines to further reduce risk.