What is a subprime mortgage? | Smart change: personal finances
Home loans designed for these types of high risk borrowers are considered subprime or subprime mortgages.
The term subprime may sound familiar thanks to the subprime crisis. Prior to 2008, mortgage lenders had much more flexible standards for approving borrowers with poor credit scores and financial histories. These were also sometimes referred to as doc-less loans because some lenders did not require documented proof of income.
Eventually, many of these borrowers defaulted on their loans. Between 2007 and 2010, foreclosures skyrocketed and banks lost tons of money, forcing the government to bail out many large banks, while others merged or were sold in the event of bankruptcy.
In response to the subprime mortgage crisis, the Dodd-Frank Act of 2010 was established to revise financial regulations to avoid a similar crisis in the future. The law includes a requirement from the lender called the Repayment Ability Rule (ATR). This rule requires mortgage lenders to establish a thorough process to assess whether a borrower is able to repay the loan on their terms, thus ending the practice of doc-less mortgages.
Lenders must also guarantee the loans according to the standards set by Dodd-Frank. Violation of these requirements could result in prosecution or other regulatory action. Additionally, at-risk borrowers are required to attend buying advice provided by a representative approved by the US Department of Housing and Urban Development (HUD).