There are mortgage or home loans for those with bad credit or those will low credit scores. It is called sub-prime loans.
Sub-prime lending is providing loans to people who have traditionally been considered as bad credit risks: those who may have difficulty in paying their financial obligations on a timely manner. Those risks might be brought about by divorce, medical emergencies, unemployment, or anything that might take a toll on the person’s financial resources. Those who have gone through bankruptcy or have had their house foreclosed are also considered as credit risks.
Because it is considered as providing a second chance to those who are considered as high-risk borrowers, sub-prime lending is also called as second-chance lending. It is also called as non-prime or near prime lending.
Who are considered as high risk borrowers?
High risk borrowers are those who have credit scores, more technically called as FICO scores, below 640. The base number varies from time to time and under certain circumstances. It will also vary among many different traditional and sub-prime lenders.
Bad credit home loans usually have poor quality collateral, higher interest rates, and less than favorable terms for the borrowers. The relatively unfavorable terms compensate for the higher credit risks that the sub-prime lenders or financing companies will be undertaking when they loan to high risk borrowers.
Investors once packaged sub-prime loans into mortgage-backed securities. When those bad credit borrowers defaulted on their sub-prime loans, the securities that were sold to several investors also defaulted. Many investors, including small time investors and retirees lost all of their investments. That contributed to the financial crisis in 2007.
The terms sub-prime loans, sub-prime risks, and sub-prime lending have gained popularity in usage and has become a by-word after the said financial crisis or credit crunch of 2007.
The proponents of sub-prime lending leaned on the concept of inclusion in asserting that sub-prime loans should always be available. As mentioned, sub-prime lending provides loans to people who could not otherwise get credit from traditional forms of lending. The concept of inclusion asserts that those who have been excluded – those who have been discriminated on, the young, and those without lots of funds in the bank to pay for a down payment on a house – should be provided access to credit.
Sub-prime loans, or more appropriately, loans with sub-prime risks, are not just those home loans for those with bad credit. Lenders and financing companies might consider a loan to be of sub-prime risk even if the borrower has “prime” characteristics such has have low debt or having a high credit score. Lenders and financing companies evaluate risks on not just the credit score of the potential borrower, by on these factors as well:
- the size of the loan applied for;
- the structure of the loan and the repayment plan;
- the nature of the loan:
- traditional repayment loan;
- interest only loan;
- standard repayment loan;
- endowment mortgage loan;
- credit card limit; or
- other arrangement; and
The definition, therefore, is not standard, although it is generally applied to those with a credit score of 650 or below.