loan that is offered at a rate above prime to individuals who
do not qualify for prime rate loans.
Subprime loans tend to have a rate that is 0.1% to 0.6% higher
than the prime rate. Although the additional percentage may
seem small, for mortgages and other large loans, this translates
to thousands of dollars worth of additional interest payments.
loans cost a lot,
but they can help mend credit history
By Michael D. Larson
It may have been a couple late payments or something as bad
as a bankruptcy, but whatever the problem, the outcome is the
same: A scarlet letter on the credit report and an "Application
Denied" stamp from the mortgage lender.
bad-credit problem traps plenty of people, but a booming business
among so-called "subprime" lenders means money likely
will be available to those looking to move into a new home or
refinance to consolidate debt.
But experts caution people to carefully weigh the benefits and
drawbacks of taking out a subprime loan. Just having one and
handling it well can help repair a damaged credit history, but
they cost thousands more in interest than standard mortgages.
think, in many terms, of my own kids," says Daniel Rich,
chief financial officer of Parsippany, N.J.-based Champion Mortgage
Corp. KeyCorp of Cleveland bought Champion in September, 1997,
to expand its subprime lending. "I would tell them, 'if
you can, wait and save money and not borrow for a few years,
there's nothing wrong with that.' That's kind of how my father
lending, by its very nature, places lenders at risk. When all
is said and done, that means banks and other players charge
higher rates for subprime loans to compensate for potential
losses from customers who may run into trouble or default. Subprime
loans also cost more because they are considered "non-conforming,"
or not up to the standards of Fannie Mae and Freddie Mac. Those
two quasi-governmental agencies buy traditional, "conforming"
mortgages from lenders, repackage them and sell them to Wall
Street investment firms as securities.
Borrowers can fall into the subprime category for any number
of reasons, and assessing how risky a customer can be a difficult
thing for lenders. The process relies less on the computerized
credit scoring methods widely favored by traditional lenders
and more on a borrower's debt payment track record, according
to subprime experts. In the end, customers get stamped with
a grade-school-like ranking: A for those with the best credit,
B, C or D for those with progressively worse histories. An E
can show up as well, but is extremely rare.
don't, as a rule, say we want a score of this or you're out.
We have our own underwriting guidelines," says Mary Chiappetta,
vice president of marketing in the home equity lending group
of Amresco Inc. The Dallas-based company originates and services
residential and commercial mortgages, offering loans to people
with A to D credit.
question, two answers
Where someone falls on the scale depends on a number of things.
And two lenders may look at the same borrower and arrive at
two different credit grades because the categories aren't set
is as simple as one time being 30 days late on the mortgage,
but otherwise good," Chiappetta says. "D could be
bankruptcy or foreclosure."
Rich: "If you have a consistent pattern of late payments
across the board, you're going to be considered a B/C borrower."
E category means most of us in top management know your name,"
Rich says. "We have instances where no way would we make
this loan except" for unusual cases. He recalls one Champion
customer who got a loan despite a poor credit history because
she didn't have money to pay the funeral home where her husband's
body was waiting for burial.
borrower's credit grade determines a number of factors, including
what rate the loan will carry and how much of a home's value
will be loaned. On a 30-year fixed mortgage, for instance, an
Amresco borrower just shy of an A rating would be able to borrow
90 percent of a new home's value at a rate of 11.5 percent,
Chiappetta says. Someone with D credit could borrow about 65
percent of the value at 13.4 percent.
a refinance loan, rather than a purchase, Champion's Rich says
a customer with D credit could expect a rate of 12 percent to
12.9 percent. Those at the top of the heap likely would see
a rate of about 8 percent.
is a candidate?
So, if that's how the subprime process works and those are the
rates, who should consider borrowing?
advice is mixed, but generally speaking, someone whose monthly
obligations are swallowing too much of the weekly paycheck might
benefit from refinancing the mortgage at a subprime rate and
taking out cash in the process to pay off debts. The cost over
the loan's lifetime will rise, but the tax-deductibility of
mortgage interest makes it cheaper than the interest charged
on most credit cards, auto loans and the like.
subprime loans can help renters become homeowners. While the
rate charged will be high, a one- or two-year history of on-time
mortgage payments will help demonstrate creditworthiness, Chiappetta
says. That, in turn, could mean a less expensive refinancing
down the road, assuming rates don't spike.
can stay in an apartment and write a check every month and not
have any kind of tax advantage, or you can go out and get a
mortgage loan at 10 percent," Chiappetta says. "We
always say, 'Why wait?' "
experts caution that getting a subprime loan means much greater
interest costs over time. A 30-year fixed loan for $100,000
at Amresco's 11.5 percent rate, for instance, would have monthly
payments of $990 and total interest of $256,505. With the 6.66
percent national average found by a recent Bankrate.com survey,
the same loan would require payments of just $643 and cost $131,346
in total interest -- about half as much.