A mortgage is a type of loan usually used by homebuyers to finance their houses. The house is the security or collateral for the loan. That is, if the homebuyer is ever unable to make the loan payments, the lender can sell the house to get the money owed. This is called foreclosing on the loan.
Because foreclosure can be costly and troublesome, lenders are hesitant to lend to homebuyers who might not be able to repay. The lenders use information about the borrowers to determine how risky lending to them might be. This information might include your credit rating (FICO score), job and earnings history, and evaluation of the borrower’s assets. In the past, the requirements for a traditional loan prevented many people from buying a house of their own.
Subprime mortgages have opened up the possibility of homeownership to those who may not have a sufficiently high credit rating or the necessary down payment for a traditional mortgage. The problem is that these higher risk borrowers are more likely to find they cannot make their mortgage payments at some time. This can lead to foreclosure.
When mortgages are foreclosed, both homeowners and lenders lose. The lenders will not get all of their money back and the homeowners lose their houses. For this reason, lenders require a higher interest rate (APR) for subprime mortgages.
These loans are rarely advertised to the borrowers as “subprime.” The term is used in transactions among financial institutions to describe the riskiness of the loan.
Be Careful With:
Interest-only Mortgages
With an interest-only mortgage you only make interest payments for the first five or ten years. This means that you do nothing to pay down the loan during the initial period. After the five or ten years are up, you still owe the full amount of the loan. Even worse, your mortgage payment will rise once the interest-only period ends. If you are not ready, you could be in trouble.- Adjustable Rate Mortgages
With an adjustable-rate mortgage, your monthly payment changes as the market interest rate changes. The difference can amount to hundreds of dollars per month. It is a bad idea to get an adjustable-rate mortgage if you would be unable to afford the highest possible monthly payment. - Balloon Mortgages
With a balloon mortgage, you make payments just as you would with a normal, fixed-rate mortgage, but you must refinance when the five or seven year period of the loan ends. After seven years, this balance will be nearly 90 percent of the initial amount borrowed. If interest rates have gone up, you will be faced with higher monthly payments. - Mortgages with No Escrow Account
With an escrow account, you are able to pay your property taxes and homeowners insurance monthly. Without an escrow account you will have to pay these large bills in lump sums. Property taxes alone can be thousands of dollars per year. For most people, it is easier to budget on a monthly basis.