Subprime Mortgages Are Less Risky Than They Used to Be. But Avoid Them If You Can

Photo to accompany story about subprime mortgages. Adobe Stock

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If you’ve lived through the financial crisis of 2008, you’ve heard of subprime mortgages. Those mortgages played, in fact, such a big part in the crisis — leading to the Great Recession —  that they were the main plot point in the 2015 Oscar-winning movie The Big Short. 

Steve Carell and Christian Bale play a trader and an investor who discover, before the crisis, that the U.S. housing market may be a giant bubble based on selling homes to people who can’t really afford them — and so make a daring bet that the bubble will collapse.  

Spoiler alert: They were right.  

We know now those homeowners were able to get loans even though they had poor, or “subprime,” credit.       

But what exactly is a subprime mortgage? And if you find yourself with a credit score in that subprime range, should you get a mortgage?    

We turned to the experts to find out.

What Is a Subprime Mortgage?

At its core, a subprime mortgage is similar to a conventional mortgage: It’s a loan from a financial institution that is intended to help borrowers purchase a home. Since the borrower has a lower creditworthiness than one with a higher credit score, the loan comes with a higher interest rate.

While the exact credit score that would qualify as subprime might vary slightly among different lenders, in general, a score below 620 would be considered subprime, says Eliott Pepper, a certified financial planner at Northbrook Financial.

Pro Tip

Experts suggest building up your credit score and waiting to apply for a conventional mortgage instead of getting a subprime or nonprime one.

Interest rates for borrowers with those credit scores depend on a variety of factors, including type of home and size of the down payment. “The idea is that interest rates are much higher on subprime loans to compensate the lender for the additional default risk they are taking on,” Pepper says.

The average 30-year fixed mortgage rate is 3.07% with an annual percentage rate or APR — meaning what you’ll actually pay — of 3.79%.  That’s for borrowers with high credit scores; subprime borrowers can expect to pay as much as 10%.  

Note, however, that the subprime mortgages you may be familiar with have taken on somewhat of a new identity in recent years. To begin with, they have a new name.

“Subprime mortgages by that name have gone away. They were a large reason why the housing crisis occurred in 2008,” says Lindsay Martinez, CFP at Xennial Planning.

Nowadays, they’re called nonprime loans. Lenders have much stricter guidelines for issuing a loan, and require a down payment as well as employment verification — which was not always the case before the 2008 crisis. Nonprime loans are also regulated far more strictly, and since 2010 they have been placed under the supervision of the Consumer Financial Protection Bureau or CFPB, as mandated by the law known as  Dodd-Frank Wall Street Reform and Consumer Protection Act.

Before the crisis and the Dodd-Frank Act, lenders would often not bother asking if the borrower could actually afford the payments. Many people could not because the qualification process was so lax, Martinez adds.

“Following the 2008 financial crisis, additional government regulation was passed to more strictly monitor the subprime industry. One significant new rule is the requirement for subprime borrowers to take part in a Department of Housing and Urban Development-approved homebuyer’s counseling course,” says Pepper.

Today, lenders are far more careful with nonprime loans. “There generally is not much of that actually happening now,” says Sarah Ponder, a certified financial planner and founder of Fiduciary Financial Education. According to data collected by Statista, non-prime mortgage loans were 28% of the total in 2007, but just 19% in 2020. 

When to Apply for a Non-Prime Mortgage

A low credit score isn’t necessarily the only reason one would apply for a non-prime loan. For example, some properties — log homes, for example, or condos in a building where more than a certain percentage of units is occupied by tenants — don’t qualify for a regular mortgage.

Non-prime loans can also be an option for foreign nationals who come to the United States with little to no credit history, as well as self-employed individuals with little taxable income, says Martinez.

But that does not mean they are necessarily a good idea. 

“While home ownership is often viewed as a barometer of financial success in the United States, we do not necessarily agree with this statement and do not encourage people to pursue a home purchase if they will be subject to the onerous costs and fees associated,” says Pepper. “We really do not see many pros to a subprime loan from a financial standpoint.”

Instead, Pepper encourages people either to build up their credit score or improve their personal financial picture. NextAdvisor contributor Bernadette Joy, founder of Crush Your Money Goals, is of the opinion that you should save for a 20% down payment on a house before you think of buying, for example — even though there are several options for prospective homebuyers who do not have that.   

And if you have a credit score that puts you in nonprime range, you can focus on getting it to a place where you might qualify for a prime loan. 

Bottom Line

Subprime mortgages, now more commonly known as nonprime, have a controversial history. While they’re certainly more regulated today than they were before the financial crisis they helped cause in 2008, they can still be a major financial burden. 

Consider carefully whether you truly need one, and keep in mind that while the housing market may be hot right now, homeownership is not necessary for building wealth.