The term “subprime” in subprime mortgage loans is more a reference to the type of borrowers that a loan is granted to. When you consider that “prime” borrowers are loan applicants whose finances are stable, have good credit history and are not delinquent with payments, “subprime”, then, is the opposite.
Subprime borrowers are those without or have a bad credit history, low credit scores and have reported payment delinquencies, whether by choice or out of circumstance. In other words, subprime loans are for borrowers who have a high probability of defaulting on the loan.
Considering the type of borrowers subprime mortgages are approved for, it’s safe to consider it as a form of high-risk lending.
Some banks use the term “non-prime” to refer to subprime loans.
Types of subprime mortgage loans
Below are three subprime loans commonly offered by lenders.
Interest-only mortgage
Subprime lending in Australia is most closely associated with interest-only mortgages.
These are home loans wherein the borrower isn’t required to make payments towards the principal loan amount for a fixed term — usually five years.
Borrowers will only make loan interest payments for this specified period before their repayments become larger when the principal payments get included.
Some borrowers take out interest-only loans with a plan to refinance the loan before the principal payments are charged. However, this is a risky plan since they may not get approved for another loan in time due to their credit history.
In many cases, interest-only borrowers end up being forced to default on the loan.
Ultra long fixed-rate mortgage
Typical fixed-rate mortgages for prime borrowers ranger for 25 to 30 years. But for subprime mortgages, lenders may offer 40 to 50 years loans at higher interest rates.
This means borrowers may end up still paying for their homes at a higher cost even well into their retirement.
Adjustable rate mortgage
This type of subprime loan refers to mortgages wherein the borrowers are allowed to decide the amount they will pay for a fixed term — usually five years. However, the difference between the actual calculated payment and the smaller amount that the borrowers pay are added to the principal.
This means that the interest rate will be calculated against a larger principal once the 5-year term ends.
A subprime mortgage loan is only one of the many types of subprime loans available in the market. It may also be offered for other types of loan products, such as personal and vehicle loans.
