Subprime vs Prime Mortgages
There are two major categories for loans for borrowers, prime mortgages and subprime mortgages. Subprime mortgages are designed for people with lower or blemished credit scores. As such, they are riskier for lenders and usually cost the borrower more.
A subprime mortgage is a type of loan awarded to those with poor credit histories, usually below 600, but often times, anything below 620 is considered low. These people would otherwise not be able to qualify for conventional mortgages. Subprime borrowers pose a higher risk to lenders. As such, subprime mortgage rates are higher than a prime mortgage to make up for the potential risk to the lenders.
There are many different types of subprime mortgages, however, the most common is the adjustable rate mortgage (ARM). An ARM initially charges a fixed interest rate, which then converts to a floating rate. The most known ARMs are a 3/27 ARM and a 2/28 ARM. However, ARMs can be a little misleading, as they have a smaller interest rate at first. This lead to many mortgage foreclosures in 2006.
Prime mortgages meet the standards set out by Fannie Mae and Freddie Mac. To be approved for a prime mortgage, borrowers must have a good credit history and an income at least three to four times greater than their mortgage payments. Borrowers with a credit score of 620 – 650 often qualify for a prime mortgage. Prime mortgages also feature rates lower than average. Additionally, prime mortgages usually require borrowers to pay a down payment, which is most commonly 10%, but can be as much as 20%. Fixed rate mortgages are the most common types of prime mortgages. Fixed rate has an interest rate that is stays the same over the loan life.
Prime mortgages save borrowers money. This is because their low interest rates lower monthly mortgage rates by hundreds of dollars. Additionally, the down payment requirements give the new homeowners immediate equity value. Furthermore, if the down payment is high enough, the lender won’t require private mortgage insurance, which can lead to even more savings.