How Do Subprime Loans Work?
Subprime loans are issued to consumers who do not qualify for a prime rate loan due to poor credit history and have higher interest rates than those offered to credit-worthy applicants. These loans are offered through credit cards and mortgages.
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Credit Cards
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Subprime credit cards offer consumers relatively small lines of credit. Take for example an offer with a $300 limit. The offer sounds manageable but often comes with hidden processing, annual and monthly maintenance fees.
Mortgages
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Subprime mortgages often require borrowers to pay off the balance in a lump sum after five years. These loans can also have a prepayment penalty for homeowners who pay off the balance early and come in three forms.
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2/28 Loan
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The 2/28 loan offers consumers a low interest rate for the first two years of the agreement. After two years the interest rate can rise as much as 6 percent.
Interest Only
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Interest only loans are structured to pay only the interest on the loan and not the principle. Payment on the principle is postponed over a specified amount of time.
ARM
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The adjustable rate mortgage (ARM) offers borrowers a low monthly payment that does not even cover the interest on the loan. The payment rate often skyrockets after a period of time, leaving the borrower in dire straits.
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- Photo Credit Image by Flickr.com, courtesy of Kevin Dooley
