Prime and subprime mortgages are built upon the same basic principle: providing a large loan with a home or other real estate property as its collateral. However, there are some significant differences between subprime (a.k.a. nonprime) and prime loans, which have had a major impact on home owners as well as lenders. Here are some of the factors in which prime and subprime mortgages have differences…
INTEREST: Nonprime loans have a higher interest rate than prime loans. In theory, this is supposed to compensate lenders for the greater chance of foreclosure and/or late payments. According to bankrate.com, there is usually a greater difference between the subprime interest rates offered by different banks than there are with prime rates.
PENALTY: Prime loans are much less likely to have a prepayment penalty than their subprime counterparts. Senate.gov indicates that Senator Dodd recently referred to the fact that about seventy percent of subprime mortgages need a penalty to be paid for making early payments. Another one of their differences is that they also more frequently require a large “balloon payment.”
APPROVAL: It is more difficult for home buyers to get approved for prime mortgages, especially if they have minimal income and/or a mediocre credit history. Borrowers with problematic credit records more frequently accept mortgages with terms that are not favorable to them, because they aren’t able to qualify for prime loans.
DECEPTION: A subprime mortgage lender is more likely to charge unreasonable fees or try to deceive borrowers into paying more interest than they need to, although this is not true for all nonprime lenders. According to NPR.org, approximately one out of ten home owners with subprime loans can actually qualify for prime mortgages.
RATES: Subprime mortgages are more frequently adjustable rate (ARM) than fixed; the Federal Reserve web site states that over 2/3rds of such loans are adjustable. This increases the possibility that borrowers will be incapable of paying the differences if interest rates undergo an unexpected increase.
Overall, subprime mortgages are considered less borrower-friendly and based upon the theory of charging home owners more to compensate for the risk suggested by their problematic credit records. On the other hand, prime mortgages are less costly to borrowers and put banks at a lower risk of non-payment. Many of these differences relate to how they are marketed and supplied; the main differences with regard to the loan itself are prepayment penalties, interest rates, and their adjustability.