Subprime loans can be dangerous; try to avoid them

Lenders may steer consumers with marginal credit towards high-priced loans

Most consumers are aware of the explosion in real estate sales during the last few years that has driven prices to previously unknown levels. With houses becoming nearly unaffordable, lenders have come up with an ever-increasing array of loan types, so that nearly everyone may qualify for a mortgage. This is even true among borrowers with low FICO credit scores, as lenders have discovered a virtual gold mine by offering loans to consumers with a poor credit history. This market, known as the “subprime” market, carries a greater risk of foreclosure than do traditional loans, but offer a much greater profit margin for the lender. Borrowers, especially those with past credit problems, should make sure that their lender doesn’t unnecessarily steer them towards one of these loans, as they can be astonishingly expensive.

The foreclosure rate for the subprime market is about triple that of the conventional mortgage market. Roughly 3% of all subprime loans end up in foreclosure, versus 1% for more traditional mortgages. Lenders offset this increased risk by raising both the interest rate on the loan and the number of points that need to be paid at closing. A “point” is 1% of the loan amount; some subprime loans can include fees of three points or more in addition to an interest rate that is several points higher than those paid by borrowers with good credit. In short, anyone with a poor payment history will pay several thousand dollars more at closing and tens of thousands of dollars more over the life of the loan than a borrower with a history of making payments on time and in full.

Anyone can see why borrowers with poor credit histories would be classified as less desirable. What many people don’t know is that a lot of lenders offer loans at subprime rates to borrowers who would actually qualify for preferred rates based upon their credit history. About 15% of all subprime loans are issued to borrowers that could have qualified for a more favorable rate. They ended up taking the more expensive money because they either didn’t know any better or they didn’t do proper research before signing the documents.

Anyone who has a history of payment problems should examine a copy of their credit report and obtain their credit score. While reports can be had for free at annualcreditreport.com,

the free reports do not include the all-important credit score. In order to obtain your credit score, you will have to buy a copy of your credit report from one of the three major credit bureaus - Experian, Equifax, or Trans Union. While examining your credit report, you can look for errors and correct them, which should help repair your credit. Fixing errors may improve your score and make you eligible for a more favorable mortgage. As a rule, you will qualify for lower interest rates if your credit score exceeds 620. This figure isn’t absolute, but it’s a good ballpark figure. If your score is above that figure and you are offered subprime rates, you should be suspicious.

Borrowers should also shop around for the best rates. The Federal Trade Commission is investigating a number of lenders for increasing their profits by falsely informing borrowers that they only qualified for subprime loans when they could have qualified for more favorable rates. If the interest rate you are quoted by your broker seems high, check with two or three other lenders and compare rates. Doing so will not hurt your credit score, and you may save thousands of dollars.