If you don’t have a great credit score or a high-paying job, applying for a mortgage can feel intimidating or like a waste of time.
To qualify for a mortgage, lenders ideally want to see that you meet the following criteria:
Good credit A low debt-to-income ratio (how much of your income you can put towards monthly debt payments) Enough income to cover your mortgage payments each month A job that provides a steady, predictable income
The higher your credit score, income, and debt levels, the more likely you are to be approved and the better the interest rate and loan terms you will be offered.
On the other hand, if you don't have a great credit score or your income or employment history is questionable, a lender may approve you for a loan, but you won't get the best rate or terms. It might not be ideal, but it sounds a lot more appealing than not approving the loan at all, and it sounds like the lender is confident you can handle the monthly payments.
Unfortunately, getting lender approval can be a bit misleading…
History and Risks of Subprime Loans
One of the main reasons the housing market collapsed around 2008 was because so many buyers were approved for “subprime” loans. These loans were offered to buyers with low credit scores or low incomes, so they were more likely to default.
But to make matters worse, many of these subprime loans were offered with adjustable rate interest rates, meaning that if interest rates rose, the monthly payments originally approved would increase after a few years. Mortgage rates eventually rose, and roughly 40% of subprime mortgages ended up in foreclosure.
In retrospect, the term “subprime mortgages” sounds like a veritable catastrophe now that everyone has some understanding of the term. But even many in the banking and finance industry were not put off by the term “subprime” and thought it was not such a bad product to offer to people looking to buy a home. So why did the average consumer think twice about it?
Unfortunately, many buyers who took out subprime mortgages felt that they had been duped by the lenders, who felt that by approving the loan, they had done their due diligence, assessing that the buyers would be able to repay the mortgage. As you can imagine, the lenders shifted the blame for the borrowers getting into a situation that was out of their control and for poor financial management.
Ultimately, the financial experts – the lenders – are to blame, but homebuyers should have thought carefully about whether they could really handle the financial commitment they were making.
Well, whoever the fault was, they're back…
Now they are called “non-prime” loans or “dignity” loans.
According to realtor.com, subprime mortgages are becoming common again, but are now called “non-prime” or “dignity” loans and are offered to prospective homebuyers with less-than-ideal credit scores and histories.
Fortunately, governments and the banking industry have taken steps to prevent another “subprime crisis,” and many experts argue that the real estate market is now much more stable than it was back then, so subprime mortgages will not cause a new market collapse.
But whether they're called subprime mortgages, non-prime mortgages, dignity mortgages or whatever, they can be harmful to private buyers if not properly informed and thoughtful.
If you've been approved for a non-prime or dignity loan, your lender may have given you the go-ahead to purchase the home, but you may be better off proceeding as if a yellow light had appeared.
Sure, banks say they will give you a loan, but you should also think carefully about whether you can really handle the monthly payments and future terms of the loan they are offering.
Do the math for yourself. Take the time to visualize your future and honestly think about whether you are ready and able to repay a mortgage. After all, it's you who will have to deal with the consequences of not being able to repay, not the lender who approved you.
Does this mean you should never buy a home if you can only be approved for a non-prime or dignity mortgage? Not at all. These loans are great for people who need looser credit requirements or who don't have a traditional job or source of income, but do have a solid, reliable source of income.
Be careful about the type of loan you are approved for and make sure you understand and weigh the risks before signing.
summary:
Subprime mortgages, which were lent to borrowers with poor credit, contributed to the collapse of the housing bubble in 2008 due to their high foreclosure rates. These risky loans often had adjustable rates that increased over time, making payments difficult for many and leading to numerous foreclosures.
Now, such loans are resurfacing under names like “non-prime” and “dignity” loans. Regulation has helped stabilize the market, but these loans still pose risks for individual buyers.
Nonprime loans can help people with poor credit or nontraditional incomes buy a home, but it's important to fully understand and consider the risks before taking out a loan. If you are approved for such a loan, carefully evaluate whether you can handle the long-term payments and terms.