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FAQ: What is a subprime mortgage?

Posted by: raindrop 6 years, 3 months ago

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The term subprime loan is used quite a bit in the media to describe the recession.  However, many people do not know exactly what that term refers to.

A subprime mortgage is a mortgage that was issued to a borrower with a poor credit history.  These borrowers oftentimes had a credit score of 600 or below.  Due to their deficient credit score, many borrowers are not able to qualify for conventional mortgages.  Prior to the mortgage market melt down, sub-prime lenders were issuing these toxic loans at high interest rates (above the prime interest level).

There were many different types of sub-prime mortgages available.  The most common was an "ARM" or an Adjustable Rate Mortgage.  These mortgages had low or affordable interest rates to start (also known as teaser rates) to start and after a certain term (often 2, 3 or 5 years) the rate would adjust.  The adjusted rate may either be fixed or a floating rate that is based on a predetermined index such as the LIBOR.

What has happened is that many of the sub-prime loans that were issued between 2005-2007 have now adjusted and are not affordable to the borrowers.  In addition to the increased interest rate at the time of adjustment, many homes values have now depreciated leaving borrowers with a mortgage they cannot afford on a house that isn't worth their mortgage.

This perfect storm has led many borrowers to default on their mortgage, which has lead to some mortgage modifications, but more often has lead to short sale or foreclosure.

What many economists are saying and the media is expanding upon is that until most if not all of these sub-prime mortgages (also known as toxic mortgages) have gone away either through refinance, loan modification, short sale, or foreclosure, our economy cannot fully recover.

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