Subprime lending

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Subprime mortgages
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"Subprime" redirects here. For the 2007 house mortgage crisis, see Subprime mortgage crisis.

In

FICO scores below 600, although this threshold has varied over time.[2]

These loans are characterized by higher interest rates, poor quality collateral, and less favorable terms in order to compensate for higher credit risk.

financial crisis of 2007–2008.[4]

Defining subprime risk

The term subprime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers.[5] As people become economically active, records are created relating to their borrowing, earning, and lending histories. This is called a credit rating; although covered by privacy laws, the information is readily available to people with a need to know (in some countries, loan applications specifically allow the lender to access such records). Subprime borrowers have credit ratings that might include:

  • limited or no debt experience;
  • limited or no possession of property assets that could be used as security (for the lender to sell in case of default);
  • excessive debt
  • the known income of the individual or family is unlikely to be enough to pay living expenses, plus interest and repayment;
  • a history of late or sometimes missed payments;
  • failures to pay debts completely (default debt);
  • legal judgments such as "orders to pay" or bankruptcy (sometimes known in Britain as County Court judgments or CCJs).

Lenders' standards for determining risk categories may also consider the size of the proposed loan, and also take into account the way the loan and the repayment plan is structured, if it is a conventional

standard repayment loan, an amortized loan, a credit card limit or some other arrangement. The originator is also taken into consideration. Because of this, it was possible for a loan to a borrower with "prime" characteristics (e.g. high credit score, low debt) to be classified as subprime.[6]

Proponents of subprime lending maintain that the practice extends credit to people who would otherwise not have access to the credit market. Professor Harvey S. Rosen of Princeton University explained, "The main thing that innovations in the mortgage market have done over the past 30 years is to let in the excluded: the young, the discriminated against, the people without a lot of money in the bank to use for a down payment."[7]

Student loans

In the

purchasing a vehicle or buying a house, since defaulters are likely to be classified as subprime, which means the loan may be refused or more difficult to arrange and certainly more expensive than for someone with a perfect repayment record.[9]

United States

Although there is no single, standard definition, in the

FICO score below 600. The term was popularized by the media during the subprime mortgage crisis or "credit crunch" of 2007. Those loans which do not meet Fannie Mae or Freddie Mac underwriting guidelines for prime mortgages are called "non-conforming" loans. As such, they cannot be packaged into Fannie Mae or Freddie Mac MBS [12]
and have less secondary market liquidity.

A borrower with a history of always making repayments on time and in full will get what is called an A grade paper loan. Borrowers with less-than-perfect credit scores might be rated as meriting an A-minus, B-paper, C-paper or D-paper loan, with interest payments progressively increased for less reliable payers to allow the company to share the risk of default equitably among all its borrowers. Between A-paper and subprime in risk is a grade called

FICO score of below 660 while Alt-A is traditionally defined as loans lacking full documentation or with alternative documentation of ability to repay .[13] The value of U.S. subprime mortgages was estimated at $1.3 trillion (~$1.84 trillion in 2023) as of March 2007,[14] with over 7.5 million first-lien subprime mortgages outstanding.[15]

Canada

The sub-prime market did not take hold in Canada to the extent that it did in the U.S.,[16][17] where the vast majority of mortgages were originated by third parties and then packaged and sold to investors who often did not understand the associated risk.

Subprime crisis

Main article: Subprime mortgage crisis

The

house-price bubble burst, property valuations plummeted and the real rate of return on investment could not be estimated, and so confidence in these instruments collapsed, and all less-than-prime mortgages were considered to be almost worthless toxic assets, regardless of their actual composition or performance. Because of the "originate-to-distribute" model followed by many subprime mortgage originators, there was little monitoring of credit quality and little effort at remediation when these mortgages became troubled.[4] Subprime loans as aggressive lending tools. Markets with a high concentration of aggressive lending facilities are at risk of a sharper fall in real estate prices after a negative shock to demand.[18]

To avoid high initial mortgage payments, many subprime borrowers took out adjustable-rate mortgages (or ARMs) that give them a lower initial interest rate. But with potential annual adjustments of 2% or more per year, these loans can end up costing much more. So a $500,000 loan at a 4% interest rate for 30 years equates to a payment of about $2,400 a month. But the same loan at 10% for 27 years (after the adjustable period ends) equates to a payment of $4,220. A 6-percentage-point increase (from 4% to 10%) in the rate caused slightly more than a 75% increase in the payment.[19] This is even more apparent when the lifetime cost of the loan is considered (though most people will want to refinance their loans periodically). The total cost of the above loan at 4% is $864,000, while the higher rate of 10% would incur a lifetime cost of $1,367,280.[citation needed]

See also

References

  1. ^ The Financial Crisis Inquiry Report (PDF). National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. p. 67.
  2. ^ Lo, Andrew W. "Reading About the Financial Crisis: A 21-Book Review" (PDF). Draft: January 9, 2012. Journal of Economic Literature. Archived from the original (PDF) on 13 January 2013. Retrieved 17 November 2013. The term "subprime" refers to the credit quality of the mortgage borrower as determined by various consumer credit-rating bureaus such as FICO, Equifax, and Experian. The highest-quality borrowers are referred to as "prime", hence the term "prime rate" refers to the interest rate charged on loans to such low-default-risk individuals. Accordingly, "subprime" borrowers have lower credit scores and are more likely to default than prime borrowers. Historically, this group was defined as borrowers with FICO scores below 600, although this has varied over time and circumstances, making it harder to determine what "subprime" really means.
  3. ^ "Subprime Lending". U.S. Department of Housing and Urban Development. Archived from the original on 2016-07-02. Retrieved 2018-09-21.
  4. ^ a b c Lemke, Lins and Picard, Mortgage-Backed Securities, Chapter 3 (Thomson West, 2013 ed.).
  5. ^ "FDIC-Guidance for Subprime Lending". Fdic.gov. Retrieved May 1, 2010.
  6. ^ Demanyank Y. (2009). Ten Myths about Subprime Mortgages Archived 2013-06-05 at the Wayback Machine. Federal Reserve Bank of Cleveland.
  7. ^ Goolsbee, Austan (2007-03-29). "Irresponsible Mortgages Have Opened Doors to Many of the Excluded". Economic Scene. The New York Times. Retrieved 2010-12-03.
  8. ^ "Student Loan Debt Exceeds One Trillion Dollars". www.NPR.org. NPR. Retrieved 19 January 2015.
  9. ^
    New York Times
    . Retrieved 17 May 2017. ..many borrowers are struggling to pay off their student loans, and the debt collection industry is cashing in.
  10. ^ Lobosco, Katie (5 June 2018). "Student loan debt just hit $1.5 trillion. Women hold most of it". cnn.com.
  11. ^ Friedman, Zack. "Student Loan Debt Statistics In 2018: A $1.5 Trillion Crisis". forbes.com.
  12. ^ Lemke, Lins and Picard, Mortgage-Backed Securities, Chapter 2 (Thomson West, 2013 ed.).
  13. ^ Alt-A Mortgages.
  14. ^ "How severe is subprime mess?". NBC News. Associated Press. March 13, 2007. Retrieved July 13, 2008.
  15. Chicago, Illinois
    . Retrieved July 13, 2008.
  16. ^ "What subprime crisis?". National Post. 2007-09-08. Archived from the original on 2016-01-30. Retrieved 2015-12-28.
  17. ^ Greg McArthur; Jacquie McNish (2009-03-14). "Canada's dirty subprime secret". Retrieved 2015-12-28.
  18. S2CID 152426044
    .
  19. ^ Gad, Sham (2007-07-10). "The Skinny on Subprime". Fool.com. Retrieved 2010-05-01.

External links

Look up subprime in Wiktionary, the free dictionary.
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