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SUBPRIME MORTGAGE LOANS
A final approach to credit and condo buying is the subprime loan. Subprime lending took it on the chin recently and nearly vanished from the face of the earth. But subprime lending has been around for decades, and it has a place in the credit markets when used properly.
Recall that one of the best ways to reestablish a credit score is by having a timely mortgage history. But if your credit has been damaged due to a life event such as sickness or the temporary loss of a job, and a property comes up that you must absolutely have, a subprime loan may be a good fit.
Subprime loans are for those with credit scores typically below 580. They require a bit more in down payment. Be prepared to pay 10 to 20 percent down for a subprime mortgage loan and also have higher rates. How much higher?
When you compare 30-year fixed rates for conventional and subprime loans, you may find a conventional rate at 6.50 percent and a subprime rate of 9.50 percent. The rates are higher, but then again there is a higher risk factor involved with recent credit problems.
Most subprime loans also offer a hybrid model that is lower than a fixed-rate mortgage to help ease the pain. If a subprime fixed rate is offered at 9.50 percent, then you can expect a 3/1 or 5/1 hybrid rate to be in the 8.50 percent range.
And because it is a hybrid, there is also one other important feature to consider: the fully indexed rate when the hybrid resets into an annual adjustable-rate mortgage. With subprime mortgage loans, the index can be astonishingly high, with indexes in the 8 or 9 percent range common.
If a subprime loan was based on the one-year Treasury bill and the index was at 4 percent when combined with a 9 percent margin, the rate would adjust to 13 percent! At 8.50 percent on a $300,000 loan, the payment in this instance would rise from $2,306 per month all the way to $3,318 per month!
That got a lot of people into trouble. When their loans adjusted, many of them faced foreclosure. This of course is the opposite of what a subprime mortgage loan is supposed to do, that is, get people into a mortgage loan and give them time to repair their credit.
The strategy with a subprime hybrid is to make sure you know what the payment could go to when the hybrid adjusts, and to make sure you can refinance into a conventional loan when your credit has improved.
The bugaboo with that strategy is that it assumes property values will increase — or hang steady at the very least. After all, historically, home prices rise over the years. But if property values go down and the loan value is actually higher than the property value, a lender won't make a loan on the property. Lenders require some equity in the property on any refinance.
Subprime loans do have a place — as long as you understand every detail of the loan and all possible consequences. But why bother? Why not simply wait it out, repair the credit, and apply later on? That's a good strategy, but if mortgage payments are lower than renting and you have some down payment, it's something to consider.
Once you take out a subprime loan if s critical to pay close attention to your credit accounts and pay them on time, every time. One late mortgage payment on a subprime loan and your score could drop below where it was when you took out the initial subprime mortgage!
Where do you find subprime mortgages? It used to be that they could be found nearly anywhere, with all banks great and small offering loan programs for those with damaged credit. With the recent mortgage debacle, they have all but vanished. They are still around, but just a handful of lenders still offer them and their guidelines have been tightened.
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