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What is a Subprime Mortgage?

March 25, 2009 | Education | Mortgage Loans | No Comments

A subprime mortgage is a type of loan given to borrowers with poor credit histories; often below a 600 FICA Score.

As a result of poor credit scores, these borrowers do not qualify for conventional mortgages. Because subprime borrowers present a higher risk for lenders, subprime mortgages charge higher interest rates, above the prime lending rate.

There are several types of subprime mortgage available. However, the most common type of adjustable rate mortgage (ARM) charges a fixed interest rate and then converts to a floating rate based on an index such as LIBOR, plus a margin. The most popular types of ARMs include the 3/27 and 2/28 ARMs.

A 2/28 ARM has a fixed rate for the first two years and then the interest rate adjusts for the next 28 years, which completes the full 30 year term of the loan.  While a 3/27 ARM has a fixed rate for the first 3 years and then adjusts for the next 27 years. The 3/27 mortgage gives a longer period of fixed payments but comes with a slightly higher rate than a 2/28 arm would.

ARMs can be misleading because of the initial lower interest rate. However, when mortgages reset to the higher variable rate, mortgage payments increase significantly. This is the main reason that has caused the sharp increase in the number of subprime mortgage foreclosures that has lead to the current mortgage melt down.

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