The housing crisis was singlehandedly blamed on subprime loans. However, they have made a comeback. Before you jump on board, know the dangerous features you should not ignore.
Not all subprime loans are bad – in fact, there are many good ones. But, certain lenders set traps for the unsuspecting. Don’t let yourself fall for these tricks. Read the fine print and understand what you are getting.
What is a Subprime Loan?
First, let’s look at the definition of a subprime loan. It’s a mortgage given to borrowers with a fair credit score. You’ll need at least a mediocre score in order to qualify even for these loans. Just what credit score you need depends on the lender. You may find some that allow scores as low as 500 or as high as 620. Most lenders will fall somewhere in between these two numbers, though.
A loan is subprime because it has a high risk of default. Typically, lenders can’t sell the loans on the secondary market. Instead, they have to keep them on their own books. This works in your favor because the lender can make up his own rules. They don’t have to follow any secondary investor’s rules.
However, every loan must fall under the Ability to Repay Rules. In other words, the lender has to make sure you can afford the loan. This means no more stated income or no income, no asset loans. The lender has to put forth a good faith effort in determining that you can afford the loan.
The Dangerous Features
Once you find a lender that can give you a loan, you’ll want to know the terms. They aren’t always favorable. That’s not to say that every lender will take advantage of you. In fact, you might not find any lenders that take advantage of your situation. What you may find, though, is that the terms differ from what you expected.
Keep an eye out for these dangerous features:
- ARMS with low teaser rates – If the interest rate seems too good to be true, don’t trust it. Ask the lender what the worst-case scenario is for the loan. In other words, how high can the rate possibly adjust? This way you know what to expect. If it’s a payment you can’t afford, try to find a different loan.
- Interest only payments – Again, the low payments initially seem like a great idea. You can easily afford the loan. However, once you enter the repayment period and you have to pay back the interest, the loan could become unaffordable.
- Balloon loans – This type of loan also carries a lower initial payment. Instead of the payment increasing, though, the entire outstanding amount becomes due. This could mean thousands of dollars. If you can’t afford to pay it off, you could lose your home.
- Excessive fees – Subprime lenders often charge more because your loan is risky. They make up for the risk of default by collecting money up front. While a few points may be warranted, paying excessive fees is unnecessary. It could put you in the red before you even begin making mortgage payments.
Don’t be afraid to ask your lender questions. Even if they send you a Loan Estimate and you don’t understand it, ask more questions. Ask about the term, rate, and fees. If something doesn’t seem right, inquire about it. If you don’t like a fee, negotiate it. If you don’t like the term, ask what other options you have.
The subprime lender is not the only one available. You don’t have to stick to lenders in your immediate area. Lenders licensed to work in your state may not even reside near you. Shop online and see what options you have. You may find a much better deal from a lender not in your immediate area.
Whatever you do, don’t fall for the common dangerous features of the subprime loan. Instead, take your time and explore your options. If you don’t receive any decent quotes, take a break and work on your application. Is it your credit that’s holding you back? See what you can do to fix it. Pay your bills on time and lower your outstanding balances. If it’s your unsteady job or a prior bankruptcy – wait it out. While waiting to buy a home might not be what you wanted, it can help you get more favorable terms in the future.