Definition
Subprime credit is any loan or product geared toward borrowers with poor credit histories.
Analysis
Subprime lending has expanded tremendously since 2002, when the Federal Reserve triggered a housing market boom by lowering the federal funds rate. Accordingly, many lenders began lowering underwriting requirements in order to increase subprime lending.
Subprime loan rates are much higher than prime rates, which are reserved for borrowers with good credit. Subprime credit is generally available to anyone with a credit score in the range of 500 to 630.
Subprime lending is viewed by lenders as being more profitable, since lenders may charge much higher interest rates in order to compensate for higher predicted risk of default. In addition, subprime borrowers tend to pay more fees related to delinquent payments.
Subprime lenders overextended themselves from 2002 to 2007, particularly in the mortgage lending industry. This has led to massive losses for some lenders due to higher default rates and widespread foreclosures.
Since 2007, underwriting requirements have become more stringent. A credit crunch has ensued, in which many lenders have tightened eligibility requirements for many loan products.
Subprime lending is an example of risk based pricing, where lenders may charge higher rates to compensate for higher default risks. It allows for some borrowers to buy on credit even if they have not demonstrated creditworthiness.
An estimated 90% of subprime mortgage loans include terms that are predatory in nature. According to the Center for Responsible Lending, predatory terms can include:
- Fees exceeding 5% of loan amounts
- Prepayment penalties
- Yield spread premiums (kickbacks)
- Loan flipping
- Unnecessary tack-on products
- Mandatory arbitration
- Steering and targeting
