What is Subprime Mortgage?

996 reads · Last updated: December 5, 2024

A subprime mortgage is one that’s normally issued to borrowers with low credit ratings. A prime conventional mortgage isn’t offered, because the lender views the borrower as having a greater-than-average risk of defaulting on the loan.Lending institutions often charge interest on subprime mortgages at a much higher rate than on prime mortgages to compensate for carrying more risk. These are often adjustable-rate mortgages (ARMs) as well, so the interest rate can potentially increase at specified points in time.

Definition

Subprime mortgages are loans offered to borrowers with lower credit ratings. These borrowers are considered to have a higher risk of default, so mainstream conventional mortgages are not typically offered to them. Lenders usually charge higher interest rates on subprime mortgages to compensate for the increased risk.

Origin

The concept of subprime mortgages originated in the United States in the 1990s when financial institutions began offering loans to borrowers with lower credit scores. Over time, this type of lending grew rapidly in the early 2000s, eventually contributing to the financial crisis of 2007-2008.

Categories and Features

Subprime mortgages are often adjustable-rate mortgages (ARMs), meaning the interest rate can increase at certain points in time. Their main features include higher interest rates and lower credit requirements. While these loans can help borrowers with poor credit obtain housing, they can also lead to higher repayment pressures.

Case Studies

A typical case is the U.S. housing market in the early 2000s, where many borrowers used subprime mortgages to purchase homes. However, as interest rates rose and housing prices fell, many borrowers were unable to repay their loans, leading to widespread defaults and foreclosures. Another case is the collapse of Bear Stearns in 2007, which held a large amount of securities backed by subprime mortgages and eventually went bankrupt due to the market crash.

Common Issues

Common issues investors might face with subprime mortgages include high default rates and risks associated with market volatility. A common misconception is that subprime mortgages are always profitable, but in reality, their high risk can lead to significant losses.

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