Paying Subprime When You Don't Need To?

According to an article on Knowledge@Wharton, subprime lending could be in trouble. We've already seen that with recent lender problems with defaulting loans. In fact, the lenders in most trouble are the subprime lenders.

Many are now talking about the potential challenges if a lot of foreclosures force a glut of homes back onto the market. And it's not just about the potential pressure on housing prices. The pressure on lenders could be huge. We've been following the Mortgage Implode-O-Meter to try to determine the health of lenders. It's surprising the number of lenders that have gone out of business in a short time.

However, there's an undercurrent to this story that goes beyond the trouble in the lending market. With all the focus on the problems with the lenders and a potential steep drop in house prices if inventory goes up, no one is asking about those who are actually paying these subprime mortgages -- and whether they should be paying such high interest rates.

Subprime loans (or bad credit loans) are generally considered to be loans that are given to people with credit scores below 620. The range of credit scores starts at 300 and goes to a high of 850. Anything above 700 is generally considered good. Those below 600 are very high risk.

What if there were people paying for subprime mortgages who had credit scores above 700?

A combination of factors has driven the subprime market; part of that was a realization that people with lower credit scores weren't necessarily such a terrible risk. Another part was the government push towards getting homeownership rates up. A third was that lenders realized that they could make a lot of money on charging higher rates to higher risk people, and offset risk effectively. This resulted in marketing of mortgage loans into "poorer" communities. However, it also appears that these subprime loans have been pushed into poorer areas in such a way that even borrowers that could have qualified for prime loans with better terms, have been given subprime loans.

Once in a subprime loan, even if the borrower realizes it's a bad deal, it can be virtually impossible to get out because of prepayment penalties. As a result, homeowners cannot refinance to get the lower interest rates, even if they realize that they could. Falling home prices seal the homeowners fate, since it may mean that a new loan would not cover the balance remaining on their current mortgage, if they switched.

However, rising interest rates may have caused a subprime borrower's payments to go up by as much as 30 to 50 percent. With this kind of cost increase, even a good borrower may fall behind in payments.

As a result, there have been an increasing number of defaults in these poorer communities. And it's happening with borrowers who could have had prime loans!

Are you one of those borrowers? Could you be in a prime loan? It might be time to refinance and get a better rate. If you are interested in a new lender, check out some of the companies that sponsor our site. You can get a free quote and compare the costs and benefits of moving to another lender.

Michael Chantrel
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