Subprime loans are pricey, but can help credit history

So maybe you've never filed for bankruptcy, foreclosed on a house or defaulted on a loan. You have, however, paid a few bills late, which lowered your credit score. If your credit score dropped below 620, you may have made yourself a subprime lending customer.

Subprime loans are a mixed bag for those with blemished credit histories. They can help renters own homes and cash-strapped folks pay off debts. They also cost more and come with significant risks. Make sure you belong in the subprime category and understand all its pitfalls before you proceed with a subprime loan.

Think about it
Experts caution people to carefully weigh the benefits and drawbacks of taking out a subprime loan. Having one and handling it well can help repair a damaged credit history, but a subprime loan can cost thousands more in interest than standard mortgages.

Subprime lending, by its very nature, places lenders at risk. When all is said and done, that means banks and other players charge higher rates for subprime loans to compensate for potential losses from customers who may run into trouble or default. Subprime loans also cost more because they are considered "nonconforming," or not up to the standards of Fannie Mae and Freddie Mac. Those two quasi-governmental agencies buy traditional, "conforming" mortgages from lenders, repackage them and sell them to Wall Street investment firms as securities.

Track record counts
Borrowers can fall into the subprime category for any number of reasons and assessing how risky a customer is can be a difficult thing for lenders. The process relies less on the computerized credit scoring methods widely favored by traditional lenders and more on a borrower's debt payment track record, according to subprime experts. In the end, customers get stamped with a school-like ranking: A, for those with the best credit, to B, C or D for those with progressively worse histories. An E can show up as well, but is extremely rare.

One question, two answers
Where someone falls on the scale depends on a number of things. And two lenders may look at the same borrower and arrive at two different credit grades because the categories aren't set in stone.

Someone with a generally good credit record, but who paid their mortgage 30 days late within the past year, could earn an A-minus. The grade of D could be the result of bankruptcy or foreclosure. Subprime lenders will look at a potential borrower's general pattern of financial behavior. If you are usually on time with your payments, you'll most likely be a B or a C consumer.

A borrower's credit grade determines a number of factors, including what rate the loan will carry and how much of a home's value will be loaned. On a 30-year fixed mortgage, for instance, a borrower just shy of an A rating would most likely be able to borrow 90 percent of a new home's value at a rate a couple of percentage points or so above the going rate. Someone with D credit could borrow less at a higher interest rate.

Who is a candidate?
So, if that's how the subprime process works and those are the rates, who should consider borrowing?

The advice is mixed, but generally speaking, someone whose monthly obligations are swallowing too much of the weekly paycheck might benefit from refinancing the mortgage at a subprime rate and taking out cash in the process to pay off debts. The cost over the loan's lifetime will rise, but the tax-deductibility of mortgage interest makes it cheaper than the interest charged on most credit cards, auto loans and the like.

And subprime loans can help renters become homeowners. While the rate charged will be high, a one- or two-year history of on-time mortgage payments will help demonstrate creditworthiness. That, in turn, could mean a less expensive refinancing down the road, assuming rates don't spike.

Still, experts caution that getting a subprime loan means much greater interest costs over time. A 30-year fixed loan for $200,000 at the higher rate of 8.5 percent, for instance, would have monthly payments of $1,538 and total interest of $353,618. Compare that with the 6.71 percent national average as of June 2006, the same loan would require payments of just $1,292 and cost $265,078 in total interest -- a savings of nearly $90,000 over the life of the loan.

Hopefully this article has given you a better understanding of subprime loans and their role in mortgage lending. We offer subprime loans as an alternative for our clients when warranted. Of course we want all of our clients to get the best product and price. Our goal at First Mutual Mortgage Corporation is; To make you a mortgage loan at the lowest rate on the best program in the least period of time with the least inconvenience to you.

For More Information on this or any other mortgage loan product, please call one of our Mortgage Loan Specialists or Apply Online Today!