We have all heard of prime and subprime mortgages. But what’s really the difference?
All Mortgage loans could be separated in two product categories:
Prime Mortgage Lending – Offer traditional mortgage products with low market competitive interest rates. Typically a down payment is required. Prime lenders will analyze credit history closely to ensure the perspective borrower fits within the prescribed risk parameters of the investors is required.
Subprime Mortgage Lending – Exotic mortgage product’s and or high interest and fee versions of traditional mortgage products. Low credit and small to zero down payment required.
subprime mortgage VS prime mortgage
The term “subprime” mortgage or “sub-prime” mortgage is used to describe a loan and or lending market that is geared towards borrowers who do not qualify for traditional mortgage loans or a “prime” mortgage. Essentially a borrower perceived to have a higher probability of defaulting will typically be offered a subprime mortgage over a prime mortgage. The risk of the loan defaulting is covered by the higher interest rate and other expenses and fees associated with a subprime mortgage. At least this was the idea.
The subprime mortgage has of recent years earned a bad reputation and has been branded the cause of the housing, mortgage, and foreclosure crisis. This is not necessarily true. The practice of subprime lending has enabled consumers to obtain home ownership of whom normally would not have qualified for a prime mortgage. Thus would have been unable to be a Homeowner.
Many of these subprime borrowers are today still Homeowners with current and healthy mortgages. The problem has come from the abuse of subprime lending and the predatory lending that has unfortunately played a big role in subprime lending.
Key Aspects of a Subprime Mortgage Loan
- Created for borrowers who did not qualify for a prime mortgage which generally have more favorable terms.
- Higher interest rates, higher closing costs and or servicing fees. The higher cost of debt is justified by the higher risk taken by the lender
- Easy going qualification process
- Small or no down payment required
- Terms and conditions of mortgage payments often are of an exotic nature
- PMI or Private Mortgage Insurance is required
- Borrower does not meet FHA standards
- Mortgage asset is usually not held by Fannie Mae or Freddie Mac
Traditionally a prime mortgage is always taken by a prime borrower or any borrower for that matter that is offered a prime mortgage vs subprime mortgage.
However some have now uncovered that many borrowers who qualified for a prime mortgage were not offered a prime mortgage but instead these clean credit borrowers were given subprime loans. This unethical lending practice is due to the incentives of those lending agents. The lending agents were given much larger commissions for subprime products, thus they pushed the subprime loan to those who would take it.
Key Aspects of a Prime Mortgage Loan
- No PMI required
- Borrower typically meets FHA borrower quality credit standards
- Often Held by Fannie Mae or Freddie Mac often hold the assets
- Offered to those consumers that have good credit (in other terms the consumers that come with the lowest risk and highest credit scores are offered prime mortgage loan agreements with favorable borrowing terms as opposed to a subprime mortgage that will generally carry less favorable terms)
- Low interest rates, low or no closing costs and or servicing fees (lower cost of debt is justified by the low risk incurred by the lender)
- Best choice for a home buyer who qualifies
- Credit unions and traditional bank and lending institutions are more likely to offer the best prime mortgage products and are also the most cautious lenders
- Traditional Down payment of 20%
- Few fees and or points comparatively, however points and fees are generally due at closing
- Borrower has past demonstrating excellent debt management habits.
Subprime Mortgage Products
- Interest Only Mortgage
- Balloon Mortgage
- Optional Rate Mortgage
- Teaser Rate ARM
- Zero Down High Fixed Rate Mortgage
- Countless other Exotic Home Loan Products
Prime Mortgage Products
- Traditional Fixed Rate Mortgage
- Adjustable Rate Mortgage – ARM
Prime VS Subprime : Economic Impacts
Mortgage Loans are practically the foundation of the modern day US economy. For decades these asset backed loans have provided a safe, sturdy, and powerful investment vehicle for banks, retirement pension funds, government funds, and countless other income driven investors. Investing in mortgage backed securities was a sure thing for Investors. On the other side they were the foundation of the American dream. Countless Americans got mortgage and worked hard for decades paying them off and accumulating wealth via equity from the steady appreciation of the American housing market. This all changed however. Almost no one saw it coming.
Subprime mortgage lending was the cause of the housing bust. The problem was that banks were making so much money off mortgages but they were running out of borrowers. So they created subprime loans with higher interest rates to make up for the greater risk. What could go wrong? Afterall they were backed by homes and housing never went down. Housing always goes up. Right?
Wrong. People started defaulting at unimaginable rates and foreclosures were happening by the millions the market became flooded with homes to sell and banks stopped lending so there were no buyers to meet the overwhelming supply.
In short prime mortgage loans are a solid and beneficial component to the economy. Subprime lending is toxic and destructive to everyone involved. Except of course the loan originators who cash in a healthy commission every time they are able to write one.