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Subprime lending (also known as B-paper, near-prime, or second chance lending) is lending at a higher rate than the prime rate. While often defined or defended as lending to borrowers with compromised credit histories, the Wall Street Journal reported in 2006, 61% of all borrowers receiving subprime loans had credit scores high enough to qualify for prime conventional loans.[1]A subprime loan is offered at a rate higher than A-paper loans due to the perceived increased risk. Subprime lending encompasses a variety of credit instruments, including subprime mortgages, subprime car loans, and subprime credit cards. The most abusive subprime lending practices are, arguably, short-term “payday” loans.
Subprime lending is highly controversial. Subprime fixed mortgages represented 6.3% of outstanding loans and 12.0% of the foreclosures started in the same period.[4]
Home Loan Refinancing
Fannie Mae has lending guidelines for what it considers to be “prime” borrowers on conforming mortgage loans - those loans they will buy or securitize into the credit market.
[edit] Subprime lenders
Subprime loans are considered to carry a far greater risk for the lender due to the aforementioned credit risk characteristics of the typical subprime borrower. In the case of many subprime loans, this risk is offset with a higher interest rate or various credit enhancements such as Private Mortgage Insurance (PMI). In the case of subprime credit cards, a subprime customer may be charged higher late fees, higher over limit fees, yearly fees, or up front fees for the card.
Equity Loan
Borrower profiles
Private Label Credit
Subprime Origination, Securitization and Servicing
Subprime mortgages
Subprime mortgage loans are riskier loans in that they are made to borrowers unable to qualify under traditional, more stringent criteria due to a limited or blemished credit history. Subprime mortgage loans have a much higher rate of default than prime mortgage loans and are priced based on the risk assumed by the lender.
Subprime mortgages totaled $600 billion in 2006, accounting for about one-fifth of the U.S. home loan market[2].
Subprime credit cards
In 2007, many new subprime credit cards began to sprout forth in the market. In a very limited number of situations, subprime credit cards may help a consumer improve poor credit scores. Lenders use the higher interest rate and fees to offset these anticipated higher costs.
The same goes for loans. Allegedly less creditworthy subprime borrowers represent a riskier investment, so lenders will charge them a higher interest rate than they would charge a prime borrower for the same loan.
To avoid the initial hit of higher mortgage payments, most subprime borrowers take out adjustable-rate mortgages (or ARMs) that give them a lower initial interest rate. Most subprime ARM loans are tied to LIBOR (London Interbank Offered Rate - a rate trading system originating in Britain).
Mortgage discrimination
Main article: Mortgage discrimination
[2] Black and other minorities disproportionately fall into the category of “subprime borrowers” because of lower credit scores, higher debt-to-income ratios, and higher combined loan to value ratios. Because they are higher risk borrowers, they are more likely to seek subprime mortgages with higher interest rates than their white counterparts.[8]
U.S. subprime mortgage crisis
Main article: 2007 Subprime mortgage financial crisis
Alt-A loan defaults also increased to 8.65%.