4 Ways Subprime Loan Lenders Take Advantage of Borrowers

Subprime loans are highly risky for both the borrower and the lender. In this scenario, a borrower does not qualify for a standard mortgage loan with a fixed rate. The lender offers a loan that has a rate below the national prime. The rate, though, is adjustable. The lender may entice the borrower into this option by explaining the benefits. The borrower is convinced he or she will be able to cover future loan costs with a rise in salary down the line. Unfortunately, this does not often occur, and subprime loans have a high incidence of default. 

Low Introductory Rates

The low introductory rates offered on a subprime mortgage loan provide only a glimpse of the cost of that loan. The low rates mean very low monthly payments, and a borrower can be tricked into thinking the loan is affordable. After the initial period, though, these rates adjust to a level far higher than national averages. The monthly payment required can quickly become unmanageable. The borrower was never given a complete picture of this monthly payment up front, and the borrower may be surprised just how high the rate can adjust given the very low starting point.

Low Application Requirements

A very methodical and low-risk lender will never give a subprime loan. Borrowers who do not qualify for loans at the national prime rate would be below that lender's standards. As a result, subprime borrowers are often forced to seek lenders with lower standards. These low standards mean the lenders are willing to accept applicants that are not actually qualified for home ownership. Subprime loans are often given with low to no down payment, without a stable income guarantee and even with a low historical credit rate. Borrowers with this type of application are the most likely to default in the future.

High Limits

Aside from setting very low standards, subprime lenders may even allow for very high limit loans. These loans, possibly even jumbo loans, will require a large financial commitment from the borrower. A borrower who is not familiar with budgeting for this type of expense will easily and quickly begin missing loan payments. In a jumbo loan scenario, the loan exceeds federally recommended mortgage limits. The monthly payments after a mortgage adjusts can be well over 70 percent of a borrower's monthly salary. If that borrower has any other financial commitments, like student loans, then the debt can quickly go into default.

Upside-Down Loans

A subprime mortgage will have extremely low payments in the beginning. Essentially, the borrower is not even beginning to reduce the principal debt. Instead, the borrower is simply chipping away at the interest fees on the loan. Since the principal debt is not reduced, if the home's value decreases, the borrower will be upside-down on the loan. This means the borrower could not cover the remaining sum owed by selling the house. When a borrower is in an upside-down loan, bankruptcy becomes a risk. The asset could not be liquidated in an emergency in order to pay down the debt in full.

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