Q: What is a “subprime” mortgage?
A: A subprime mortgage is a mortgage offered to a borrower with a “subprime” credit score below 620. Most consumers’ credit scores range from 600 to 700.
Q: If my credit score is subprime, how will this affect my mortgage?
A: Generally speaking, lower credit scores mean higher risk to lenders. Lenders will therefore charge higher interest rates on such loans to cover the losses they may incur from loans that are not repaid. Unfortunately, these higher interest rates, combined with other common features of subprime mortgages, can result in a loan that is “predatory” in that the loan is made for the lender’s own benefit rather than the borrower’s.
Q: What is predatory lending?
A: Predatory lending describes practices of lenders that are designed to take advantage of consumers. Borrowers with subprime credit can be the target of predatory lenders because it is difficult to get favorable loan terms when a borrower has subprime credit.
Q: My credit score is below 620. What predatory lending tactics should I watch out for when shopping for a mortgage?
A: Be aware that lenders may not use the term “subprime” to describe the mortgages they offer; they may use a less negative term such as “non-prime.” Pay attention to the interest rates on such loans, which can be extremely high. However, to attract a borrower with subprime credit, a lender may offer a low interest rate, but at a price that may include prepayment penalties, balloon payments, high closing costs, or excess fees to compensate for offering a “good” interest rate to a borrower with a poor credit history. You should be aware that few lenders are making subprime loans at this time.
Q: What are prepayment penalties and balloon payments?
A: Because lenders make money from interest payments, they benefit when borrowers use the entire loan term to pay off a loan. If a borrower pays off a loan early in its term, the lender will lose out on income from interest and related sources. So, to make up for this lost interest income, the lender may charge a prepayment penalty. A lender also may offer a lower interest rate in exchange for a large payment at the end of the loan term (the “balloon payment”). Since balloon payments are usually too large for consumers to cover with their disposable monthly income, many borrowers will have no choice but to refinance or risk foreclosure in order to make the balloon payment. Refinancing will often mean additional closing costs and other fees.
Q: What can I do to get a favorable loan and avoid predatory lenders?
A: First, obtain your credit score and determine what you can afford and what interest rates you will likely be offered. Second, be wary of telephone and mail solicitations. Contact lenders yourself. Third, shop around; the lending industry is competitive, and lenders will want your business even if your credit history is poor. Fourth, before signing on the “dotted line,” read the fine print, ask questions, and reconsider what you can afford. Just because you are approved for a specific amount doesn’t mean you should borrow the entire amount. A good rule of thumb for an affordable/reasonable monthly house payment is 15 to 35 percent of spendable monthly income. It is also wise to consult an attorney before signing anything.
Q: What can I do if, after I’ve signed loan documents, I change my mind or I see something in them I don’t like?
A: Under the Truth-In-Lending Act (TILA), certain home equity loans are subject to a three-day right of cancellation—no questions asked. Unfortunately, initial mortgages are not subject to this right, so consumers must be particularly careful when purchasing their home not to enter a loan that will be difficult to pay off. Contact a consumer assistance organization or someone you trust to help you review any and all loans you are considering. Also, call the lender and ask questions. If the loan is a home equity loan that is subject to TILA’s three-day right of cancellation, and you choose to cancel the loan, do so in writing so that the cancellation is effective under the act.
Q: Can any government or private agencies help me get a mortgage if I have subprime credit?
A: Fannie Mae and Freddie Mac are government-sponsored entities that offer mortgages to borrowers with subprime credit. The vast majority of loans to borrowers with bad credit are provided through Fannie Mae and Freddie Mac, so your first step should be to apply for one of these government-sponsored loans.
Q: Where can I go for more information and for assistance with subprime mortgages and predatory lenders?
A: A number of governmental and private organizations are involved in combating predatory lending, including, for example, the American Bankers Association, the National Home Equity Mortgage Association and the Federal Trade Commission. For consumer information about subprime mortgages and predatory lending, visit www.hud.gov, www.usdoj.gov, www.fdic.gov or www.ftc.gov.
This “Law You Can Use” column was provided by the Ohio State Bar Association (OSBA). It was originally prepared by attorneys Russell D. Kornblut and Nathan G. Haskell, and updated by Cleveland attorney Russell D. Kornblut.