A subprime mortgage is a type of loan which is offered to home buyers who have bad credit scores, usually scores lower than 600. These buyers often don’t qualify for standard fixed mortgages, which is why they turn to subprime lenders.
Subprime mortgages usually take the form of adjustable rate mortgages, abbreviated ARMs. ARMs usually have a very low interest rate to start with which is fixed for several years.
After that, the mortgage rate becomes adjustable, and floats based on a national index. If mortgage rates across the country drop, yours will too. If they surge, yours will rise in turn.
Is getting a subprime mortgage a good move? This depends on your situation and your prospects. They can work great for some people, but for others they should be avoided.
At the very least, you should use caution when examining ARMs, since they played a major role in the foreclosures which are now turning many responsible homeowners out of their investments.
As mentioned previously, most adjustable rate mortgages start out as fixed rate mortgages for a certain number of years. During this time, subprime borrowers usually enjoy very low interest rates, typically much lower than the interest rates which are dominating the housing market.
There are different types of subprime mortgages with different timeframes for the fixed component. Typical fixed rate time frames include a year, two years, three years, or five years. After that the interest rate on a subprime mortgage is released to float against the current housing index. At that point it is subject to the ups and downs of the housing market for better or for worse.
This point cannot be pointed out enough. A lot of people missed it when they signed up for their own ARMs in the 90s.
During the housing bubble, lots of homeowners were lured into getting subprime mortgages. Drawn in by the promise of initial low interest rates, they dove right in—and now many of those same homeowners are being foreclosed on because they cannot afford the high interest rates which resulted after the housing bubble burst.
These people were very confident when they purchased their homes that they were doing the smart thing and investing in their futures. Now their homes are worth less than what they are paying on them, and they are in losing investments.
Does this mean that you shouldn’t get a subprime mortgage? Not necessarily; it depends on how long you are planning to stay in the house. If you plan to be out in less time than it will take for the interest rate to convert, you may as well take advantage of those low interest rates and then get out with the money you’ve saved.
If you’re buying a home for life though (or for a decade or two), then you probably should consider a fixed rate mortgage instead, particularly in these turbulent economic times.
With unemployment rates high, the housing market in an uproar, and uncertainty in the government, interest rates are bound to be unstable in the coming years.