It rang in as the “word of the year” in 2007, according to the American Dialect Society. And chances are, you’ll spot “subprime” popping up even more during 2008. Just what is the buzz about? And more importantly, what does it mean for you? Here’s the scoop on subprime and how it will affect you this year.
What It Is: A subprime mortgage is a home loan for people with less-than-perfect credit. Those who have a credit score below 620 (from a scale that ranges from 300 to 850) are considered risky borrowers. Lenders offer them a loan, but with extra strings attached. Subprime mortgages usually include higher interest rates and more fees. In short, these loans allow people with poor credit to purchase a home, but they are more expensive than mainstream loans.
Why It Didn’t Work: Housing prices steadily rose from 1996 to 2006. As values increased, many people wanted to buy homes. Some of these home-seekers did not have stellar credit, so lenders encouraged them to sign up for a subprime mortgage. By 2006, about 20% of the total U.S. loan market consisted of subprime mortgages. That’s when things got shaky. Many subprime mortgages came with an initial low interest rate, known as a “teaser” rate. After a period of time, however, this interest rate increased, making the mortgage payments higher. Many borrowers could no longer make their house payments. On top of that, housing prices started to drop. This made it difficult to refinance or sell. As a result, many people with subprime mortgages have defaulted on their loans. In some cases, this has resulted in foreclosures.
What It Means for You: You may not be a homeowner struggling with a subprime mortgage, but you’ll still feel the effects of the crunch. One of the biggest results of the subprime scenario has to do with loans. Banks are tightening the borrowing process. They are hesitant to hand out money to just anyone (and rightly so). If you need to take out a loan, plan to turn in more paperwork than before. You’ll likely need proof of your income, your credit score will be checked out, and you may have to make a higher down payment. If your credit score is low, concentrate on bringing it up. Begin by paying all of your bills on time. When it comes to credit cards, keep the balances low. Don’t open more credit-card accounts if you don’t need them.
If your credit score is high, you will have less trouble securing a loan. If you’re on the lookout for a home, you may be able to take advantage of the current situation. Due to foreclosures, many homes are selling for a good price. You’ll have a wide selection of living options at affordable costs. As you look, consider how long you’ll be in the area. If you plan to leave in less than five years, you may be better off renting. However, if you plan to stick around for more than five years, now is a great time to snatch up a home. Hang on to it, and you’ll be able to ride out the subprime storm and sell high.
