Subprime Loans

Subprime loans are loans offered to people who otherwise would not be able to afford a loan. People who are credit worthy are those who have a demonstrated ability to pay back the loan. Subprime borrowers are those who would be turned away by conventional lenders because their credit rating pointed to a reasonable probability that the loan would not be repaid, but would end in default.

Those who need to borrow are those who lack the capital to achieve some goal. In the case of subprime loans, in recent decades in the United States, a very common goal was home ownership. However, other types of subprime credit were granted for a number of [Page 1511]reasons by lenders. While lenders who give the largest loans are banks for home ownership, many credit companies lend for the purchase of automobiles. These are the two largest purchases made by most people. Also, many companies including well-known brands of clothing, jewelry, and other consumer goods have created credit companies or joined with them to make subprime loans to keep sales flowing.

The interest rate on subprime loans is usually higher than traditional loans, making them more expensive for those getting the loan. Such loans are usually to people with limited or small incomes. The higher interest charged meant that the cost of the loan increased by thousands of dollars over the life of the loan. In addition, to make the loan affordable in terms of monthly payments for paying the interest and principal, the life of the loan was usually longer, thus also adding to the cost of the loan.

Getting a subprime loan for those with limited means may have been their only realistic option for getting a credit card, consumer loan, or home mortgage. Even with a higher interest rate, it was possible to get credit at a subprime rate to repair a bad credit rating due to unforeseen circumstances such as illness, job loss, bad debt management, or other reasons such as the damage done to a family unit through divorce. Subprime lending is also called near-prime, nonprime, and second-chance lending. Those who get subprime loans are sometimes referred to as underbanked, meaning they lack bank accounts with substantial deposits.

All borrowers have a credit history that tells the story of their borrowing and repayment. Those borrowers with excellent or good credit ratings are those who have repaid loans promptly. Those borrowers with low or bad credit ratings have repaid slowly with delinquencies in prompt repayment or have defaulted on the loan. In contrast, lenders also have a lending record that tells the story of loans made, repaid, not repaid, and the money made and lost on the loans. All lenders, to stay in business, have to recover the principal on loans plus interest. They must incur only a few losses to make money for the creditor for the risks incurred and for increasing the capital available for lending.

C-paper is a subprime loan security that is expected to have a return that is above the prime rate of interest. Nonconforming loans in the United States are those that do not meet the standards of Freddie Mac and Fannie Mae. The reason for not meeting the standard can be any one of a long list of factors. In addition, bank loans to self-employed persons or on property that cannot be sold in the usual real estate markets may be subprime.

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