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I didn't want to short-change y'all.Subprime Lenders DefinedA sub-prime lender is one who lends to borrowers who do not qualify for loans from mainstream lenders. Some are independent, but increasingly they are affiliates of mainstream lenders operating under different names.Sub-prime lenders seldom if ever identify themselves as such. The only clear giveaway is their prices, which are uniformly higher than those quoted by mainstream lenders. You do want to avoid them if you can qualify for mainstream financing, and I'll indicate how shortly. There are lenders who offer both prime and sub-prime loans, and one of them is referred to below. For borrowers who aren't sure where they stand, dealing with a lender who offers both has a distinct advantage. They will try to qualify you for prime and only if that fails will they drop you to subprime. Lenders who are strictly subprime might refer a prime borrower to an affiliated prime lender, but their financial interest dictates otherwise.Subprime Borrowers DefinedA subprime borrower is one who cannot qualify for prime financing terms but can qualify for subprime financing terms. The failure to qualify for prime financing is due primarily to low credit scores. A very low score will disqualify. A middling score might or might not, depending mainly on the down payment, the ratio of total expense (including debt payments) to income, and ability to document income and assets.Some other factors can also enter the equation, including purpose of loan and property type. For example, a borrower who is weak on some but not all of the factors indicated in the paragraph above might squeak by if purchasing a 1-family home as a primary residence. But the same borrower purchasing a 4-family home as an investment might not make it.Subprime Lending TermsSub-prime lenders base their rates and fees on the same factors as prime lenders. For example, rates are higher the lower the credit score and the smaller the down-payment. However, the entire structure of rates and fees is higher at sub-prime lenders to cover the greater risk and higher costs of sub-prime lending.A higher percentage of sub-prime than of prime loans go into default. Sub-prime lending costs are also higher because more applications are rejected and marketing costs are higher.Among subprime loans that don't default, a higher percentage prepay early. Prepayment penalty clauses are often mandatory, and a high percentage of subprime loans have them. On the other hand, escrow of taxes and insurance, which is required in the prime market unless the borrower pays for a waiver, is often not required in the subprime market.The 2/28 ARMA very common mortgage in the subprime market, which I have never seen outside of that market, is the 2/28 ARM. This is an adjustable rate mortgage on which the rate is fixed for 2 years, and then reset to equal the value of a rate index at that time, plus a margin. Because the margins are high, the rate on most 2/28s will often rise sharply at the 2-year mark, even if market rates do not change during the period.For example, the rate is 8% for 2 years but the index is currently 4% and the margin is 6%. If the index remains at 4% after 2 years, the loan rate will jump to 10%.Some borrowers with poor credit scores take a 2/28 at a high rate and plan to rebuild their credit during the 2-year period. Their plan is to refinance at a better rate at that time. The major threat to such a plan is a prepayment penalty that runs past two years, which some do; and a lender who fails to report their payment history to the credit reporting agencies. Borrowers should be on their guard against both.

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