Understanding Different Types of Subprime Home Loans

Understanding Different Types of Subprime Home Loans

A subprime mortgage is a loan extended to borrowers with credit scores below 640 or without a credit history. According to the Federal Deposit Insurance Corporation, such borrowers are often characterized as those who have experienced delinquencies, bankruptcy, low income, or poor credit history. Individuals who have missed two or more payments within a year also fall into this category.

Since these loans carry higher risk due to the borrower’s financial history, lenders charge elevated interest rates to compensate for potential defaults.

Subprime loans come with various interest rate structures based on the borrower’s profile and the lender’s policies. Here are some common types of subprime mortgage options available to those with less-than-perfect credit:

Fixed-Rate Subprime Loan
This type offers a long-term fixed interest rate, often spanning 40 to 50 years, much longer than the typical 30-year mortgage. While this reduces monthly payments, it usually involves higher interest rates. Borrowers should compare offers from different lenders to find the best deal, preferably dealing with reputable banks.

Interest-Only Mortgage
With this option, the borrower pays only the interest for a set period—typically five, seven, or ten years. During this time, paying toward the principal is optional. After the interest-only period ends, the borrower begins paying both principal and interest, with options to refinance for better rates or pay off the mortgage in a lump sum.

Adjustable-Rate Mortgage (ARM)
An ARM starts with a fixed interest rate for an initial period, then switches to a variable rate tied to an index like ICE LIBOR plus a margin. Initially, payments are lower, but they can increase when the rate adjusts. ARMs offer the chance for payments to decrease when interest rates drop, providing potential savings.

Blended or Convertible Mortgage
This unique mortgage involves a substantial down payment, often around 10%, and carries higher interest rates for a fixed period—commonly five years. If payments are timely, the lender reduces the mortgage balance based on the interest paid, reducing future interest and potentially lowering rates to prime level.

While subprime lending involves higher risk for banks, it also presents significant earning potential. Many individuals with impaired credit opt for these loans to finance homeownership.

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