Sub Prime Lender Underwrites Riskier Loans

2007-03-08 10:33:40

( Financial )



Sub prime lenders make loans that generally are riskier than loans written by prime lenders. Many of them are independent companies, but an increasing number have become affiliates of prime mortgage lenders. Sub prime lenders do not call themselves as such, but you can identify them in other ways.

Advertising and Target Markets

You can usually distinguish sub prime lenders from prime mortgage lenders by their advertisements. You’ll observe that a sub prime lender's ads are targeted towards potential borrowers who have trouble getting a loan, and often the emphasis is on the lenders’ flexibility and personalized service. Thus, sub prime lenders company names often use words like acceptance and consumer.

You normally associate sub prime mortgages with those borrowers that have mediocre credit scores and unfavorable marks in their credit histories. Indeed, you will see that low credit scores are the primary reason borrowers obtain sub prime loans. But the sub prime lender also serves borrowers who may not be able to purchase the home they want or, in some cases, any home at all.

Pricing and Costs

You can also spot a sub prime lender by the loan price, since this is normally higher than the prices quoted by prime lenders. Since they take on riskier borrowers and riskier loans, sub prime lenders apply more flexible loan underwriting standards. In return, they have to charge higher interest rates and closing fees.

Sub prime lenders also justify higher prices by higher servicing costs. Sub prime loans require more aggressive servicing because delinquency and default rates are higher in the sub prime mortgage market. You call this risk-based pricing, which is a key aspect of sub prime mortgage lending.

You are also likely to see sub prime loans having prepayment penalties, balloon payments and negative amortization. Though useful as counterbalance to lending risks, these terms can be burdensome.


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