What does Subprime mean?

In 2007 the word subprime suddenly went from being a seldom-used mortgage industry term to a commonly known household word. The notoriety happened because subprime loans caused severe turmoil in the mortgage industry and led to historically high rates of real estate foreclosures. But even though most of us now understand the negative effects from subprime loans, we may not be familiar with the actual meaning of this category of mortgages.

“Subprime” basically means below prime, so subprime loans are those loans made to people who have less than perfect credit and cannot qualify for regular “prime” loans. If a borrower has trouble verifying enough income, has bad credit, or has a bankruptcy on his or her record; they will not be able to borrow at the most competitive and attractive interest rates. But to help these consumers still get the money they need, lenders popularized a special category of loans called subprimes.

In exchange for qualifying less than desirable borrowers, subprime lenders charge higher rates of interest, have more expensive fees, and often impose severe penalties or fees if you pay off your loan early.

Many people used subprime loans with adjustable rates to buy houses during the last bull market in real estate. But as interest rates rose and home prices fell, they found themselves unable to make their payments or sell or refinance their property. Thousands of subprime borrowers defaulted, causing financial woes for themselves as well as for their lenders, and some of the biggest subprime lenders went out of business.

Despite the problems, subprimes still provide a valuable means of getting financing for those who cannot qualify for traditional loans. But in the future they will carry much stricter regulations, closer scrutiny of a borrower’s ability to repay the loan, and will not be as aggressively marketed to the masses as they once were.

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