Subprime lenders have subprime loans that they offer to people who cannot qualify for a prime rate loan. Subprime loans will have higher rates than the prime rate that is linked to conventional loans. Borrowers who use subprime loans are individuals who have been rejected by traditional lenders due to low credit scores, low fico scores, etc. These factors give traditional lenders the leverage to turn them away as they pose a bigger risk in regards to defaulting on their payments.
Subprime loans are associated with a higher risk of defaulting due to the aforementioned factors. This leads to the loans having higher interest rates, closing costs, and typically require a larger down payment. Each point tacked onto the percentage of interest can add up to tens of thousands of dollars that can accrue over the time of the loan remaining active.
Subprime loans can be repackaged and then sold yet whenever they are bought on the market the loan will carry credit risks. There will be less of an interest rate risk associated with the subprime loan than there is for prime loan packaged securities.
Subprime Lenders & Predatory Lending
There are a plethora of subprime lenders who center their business around these type loans that have higher interest rates. Borrowers who are denied lower interest rates for various reasons are often approved by these businesses so they can have access to funds in order to buy property or build their respective businesses.
Predatory lending is when a lender uses irregular lending practices that entices a borrower into taking on a loan that is littered with extremely high fees and interest rates. Placing certain individuals who do not qualify for traditional loans in these types of agreements, greatly increases their chance of defaulting on the payment.
It is important to note the negative effect that the abuse of subprime lending can have on the economy over time. Excessive use of this type of loan was one of the main contributors in the 2007-2008 recession that was one of the worst depressions in decades. The Federal Deposit Insurance Corporation (FDIC)
Subprime Lenders Evaluation Process
Risk-based pricing systems are used by subprime lenders in order to compute the various terms and stipulations that include interest rates and loans. The risk-based pricing system includes different factors such as credit history, current credit score, as well as employment status as well as income. The Equal Credit Opportunity Act that is in place prohibits these lenders from factoring in different factors such as national origin, race, color, gender, age, or marital status.
Who Do Subprime Lenders Target?
Subprime lenders typically lend to borrowers who have low FICO scores that are usually around 660 and can dip significantly lower. The Fair Isaac Corporation uses a blend of payment history, accounts owed, new credit, length of credit history, as well as credit mix in order to compute a credit score. Each category has its own percentage that weighs differently.
Auto loans and mortgages are some of the more common loans that are given out but are only a few of the options that are available. Subprime lenders also are afforded options in terms of what they can offer for loan structures, fixed rate, adjustable rate, interest only, and dignity subprime loans.