Subprime - Explained
What is Subprime?
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Table of ContentsWhat is Subprime?How Does Subprime Work?Subprime Mortgages and the Global Financial Crisis
What is Subprime?
Subprime refers to a category of borrowers with poor credit rating or bad credit history. Lenders who offer subprime loans call this type of loan a second-chance loan or subpar lending. It is given to individuals who have tarnished credit history. Subprime loans often have higher interest rates and overall credit risks than other forms of loans. Subprime is a term that emanated from prime rate, this describes how individuals and corporations with fantastic credit rating and credit history are perceived. Borrowers who do not maintain repayment schedules in loans are often exposed to subprime loans which have unfavorable terms.
How Does Subprime Work?
The most common category of borrowers that are exposed to subprime loans are those with poor credit history due to inability to maintain loan repayment schedule or difficulty in upholding the terms of the financial contract. However, in certain situations, some borrowers despite having a good credit history can be categorized as subprime. This is as a result of the failure of borrowers to provide verification of assets and income during the loan agreement. Loans under subprime classification are no income/no asset (NINA) loans and SISA loans (stated income and stated assets).
Subprime Mortgages and the Global Financial Crisis
As a result of the serious effects of the 2008 global financial crisis, subprime mortgages and loans had an adjustable interest rate that enables borrowers make low payments at the initial phase. This initial phase with extremely low payments was better three to five years after which the interest rate would be adjusted and become somewhat expensive, making it difficult for borrowers to continue with the payment. Prior to the period of the global financial crisis, subprime loans were sold as pool mortgage investments to many investors. In this case, all the borrowers cannot default, even if some defaulted, the pooled mortgages will still stand as a strong investment. During this period, the loans were made to individuals who defaulted in payment as a result of an adjustment in the interest rate. This resulted in the end of pooled mortgage investments and the huge debt in turn contributed to the global financial crisis.