Back to Glossary Terms

Subprime Loan

A subprime loan is a loan offered to people who do not qualify for a conventional loan, either because of low income, a high loan-to-value ratio, or poor credit history.

A subprime loan is offered to people who do not qualify for a conventional loan, because of factors like low income, a high loan-to-value ratio or a poor credit history. A subprime loan generally carries a higher interest rate than a conventional loan.

A subprime loan is available to potential borrowers with poor credit scores.  Such people are referred to as subprime borrowers. Borrowers considered risky to lenders can receive financing for a home mortgage through a subprime loan, but the loan generally carries a higher interest rate.

There was a time when it was extremely difficult for a subprime borrower to obtain financing to buy a home. Today, it is a bit easier but subprime financing come at a price. Subprime loans carry higher interest rates than prime loans.  Lenders generally offer a subprime loan when the borrower fits the following characteristics:

• a FICO score below 660
• two or more 30-day delinquencies in the last 12 months
• one 60-day delinquency in the past 24 months
• a foreclosure in the last 24 months
• a bankruptcy in the last 60 months
• a debt-to-income ratio of 50 percent or more, or
• trouble paying for month-to-month living expenses

While these factors can cause a potential borrower to need a subprime loan, they don’t necessarily mean you must get one. Lenders do evaluate the above criteria when making a decision, but they also look at each borrower on an individual basis. There are no set rules.

The higher interest associated with a subprime loan can wind up making a big difference in the borrower’s monthly mortgage payments and in the overall cost of the loan. In fact, a higher interest rate could mean tens of thousands of dollars in additional interest over the life of your mortgage.

It is important to have a good credit score if you want to avoid paying higher interest on a subprime loan. Maintaining a good credit history is the key to a better score. Pay your debts on time. Don’t miss a payment, even if you just make the minimum payment each month. Also, work hard to pay off outstanding debt, especially credit card debt.  And, don’t open unnecessary accounts. As tempting as it can be to open a store credit card to get a quick discount, this can cause long-term damage to your credit score. Even if you do not keep a balance on store credit cards, they can hurt your credit history. The inquiry into your credit and the open account can lower your credit score.

For some borrowers, subprime loans are the only option. If this is the case for you, you may want to try to improve you credit score before requesting your loan.