As a licensed real estate professional in your state, you must understand the different financing options for buyers. Very few buyers can buy real estate outright; most people will need to borrow money. Lenders have two general categories of loans: prime and subprime. In this post, we will take a closer look at the difference between prime and subprime loans for mortgages.
What Is a Prime Loan?
A prime loan is a loan based on the prime interest rate. The prime interest rate, determined by a country's central bank, is the rate used by commercial banks for loans to their most trustworthy borrowers. In other words, the prime rate is the best interest rate you can get for a loan. It is reserved only for the best, most secure loans. It is also the rate banks use to borrow from each other.
To qualify for a prime loan, a borrower needs a higher credit score and good assets. Different lenders will have different credit score requirements, but in general, a score of 660 or above will qualify you for a prime loan. The higher the credit score, the better a borrower's history of making loan and bill payments.
As the name implies, a prime mortgage loan will have an interest rate close to the prime rate. If you qualify for a prime or super-prime loan, the bank has decided you are trustworthy and a low-risk borrower.
A super-prime loan is a loan with even better terms than a prime one. Reserved only for the most secure and trusted borrowers, a super-prime loan will have the lowest interest rate and the lowest fees. It will also need a smaller down payment. If you have a credit score over 720, you may qualify for a super-prime loan, depending on the lender.
What Is a Subprime Loan?
A subprime loan is a loan given to borrowers with a lower credit score and fewer assets. These financial conditions tell a lender that you are a higher-risk borrower. Credit scores of 580 to 619 typically qualify for subprime loans. The interest rate for a subprime mortgage will be several percentage points above the prime rate.
A subprime loan will have higher fees and a higher interest rate to compensate for the risk the bank takes lending to a less reliable borrower. A subprime borrower may also have to pay a bigger down payment on the property before their mortgage is approved.
One of the risks of subprime mortgages, from the borrower's point of view, is predatory lending. As we learned in the 2008 subprime loan crisis, many unscrupulous lenders preyed on vulnerable people. These lenders knowingly gave money to home buyers who could not make their payments, eventually leading to the events of 2008. Many of these loans were predatory.
Not every subprime loan is predatory, but they are more likely to be so. This is why it is important to carefully review the loan terms before signing on the dotted line. Loans from reputable banks are less likely to be predatory.
How Is the Type of Loan Determined?
Here is an overview of what lenders use to decide the type of mortgage a borrower gets:
Credit score
Credit history
Assets
Income
Mortgage amount
Down payment offered
There may be other factors depending on the lender, but these are the basic ones.
Borrowing money for a mortgage is a big financial step for anyone. As a real estate professional, it's important for you to understand the different types of loans a buyer can get for a home. Safer loans get better ("prime") rates, while riskier borrowers receive a different ("subprime") kind of loan.