Subprime lending - Is the prime topic?

Subprime lending (also called B-Paper,near-prime, or second chance lending)is a general term that refers to the practice of making loans to borrowers, who do not qualify for the best market interest rates because of their deficient credit history. Subprime lending is risky for both lenders and borrowers due to the combination of high interest rates, poor credit history, and murky financial situations often associated with subprime applicants. A subprime loan is offered at a rate higher than A-paper loans due to the increased risk.

Subprime lending is highly controversial. Opponents have alleged that the subprime lending companies engage in predatory lending practices such as deliberately lending to borrowers who could never meet the terms of their loans, thus leading to default, seizure of collateral, and foreclosure.

Occasionally some borrowers might be classified as subprime despite having a good credit history. The reason for this is because the borrowers has elected to not provide verification of income or assets in the loan application process.

Definition of subprime lending

While there is no official credit profile that describes a subprime borrower, most in the United States have a credit score below 620.

Subprime lenders

To access this increasing market, lenders take on the risks associated with lending to people with poor credit ratings. Subprime loans are considered to carry greater risk for the lender due to the aforementioned credit risk characteristics of the typical subprime borrower. Lenders use a variety of methods to offset these risks. In the case of many subprime loans, this risk is offset with a higher interest rate. In the case of subprime credit cards, a subprime customer may be charged higher late fees, higher over limit fees, yearly fees, or up front fees for the card. Subprime credit card customers, unlike prime credit card customers, are generally not given a "grace period" to pay late. These late fees are then charged to the account, which may drive the customer over their credit limit, resulting in over limit fees. Thus the fees compound, resulting in higher returns for the lenders.

Subprime borrowers

Subprime offers the opportunity for borrowers with less than ideal credit to gain access to credit. Borrowers use this credit to purchase homes, or in the case of a cash out refinance, finance other forms of spending such as purchasing a car, paying for living expenses, remodeling a home, or even paying down a high interest credit card. However, due to the risk profile of the subprime borrower, this access to credit comes at the price of higher interest rates.

Generally, subprime borrowers will display a range of credit risk characteristics that may include one or more of the following:

• Two or more loan payments paid past 90 days due in the last 12 months, or one or more loan payments paid past 60 days due the last 36 months;
• Judgment, foreclosure, repossession, or non-payment of a loan in the prior 48 months; Bankruptcy in the last 7 years;
• Relatively high default probability as evidenced by, for example, a credit bureau risk score (FICO) of 660 or below (depending on the product/collateral), or other bureau or proprietary scores with an equivalent default probability likelihood. The loans in this classification are called stated income and/or stated asset (SISA) loans or even no income/no asset (NINA) loans.