What Kind of Borrower Am I?
Current homeowners looking to refinance, or soon to be homeowners looking to buy need to know what kind of borrower they are (in they eyes of lenders) before they rush into any mortgage. Typically borrowers fall into 3 categories, prime, "Alternative A", and sub-prime.
Borrowers who are viewed as 'prime borrowers' easily qualify for a lender's best interest rates and usually has a FICO score in the low 700s. As a prime borrower you should qualify for a mortgage interest rate that is less than the prime rate (check today's rate).
Borrowers with good credit but not yet viewed as Prime fall into the Alternative A category. Alternative A borrowers are considered less risky than a subprime borrower but aren't as creditworthy as someone in the prime category. The inability to verify income is a factor of Alt-A borrowers. The interest rate Alt-A borrowers pay is lower than a subprime loan but not as low as a Prime borrower.
Subprime loans are typically made to borrowers who have spotty credit records. The interest rates on these loans are usually at the prime rate or higher and they have nontraditional terms which are attractive yet risky. Some of the nontraditional terms will allow borrowers to pay interest only or offer them adjustable rates that start really low (1 or 2%) but are subject to sudden spikes after a certain time. These low teaser rate loans often have high penalties for the borrower if they refinance the loan prior to the spike in the interest rate.
Generally you enter subprime territory when you have a credit score in the low 600s. Each lender sets its own benchmark for subprime customers. One lender may set the bar at a credit score of 650 or below, another might set the bar at 620.
But a low credit score isn't the only factor that may push you into a subprime loan. You might only qualify for such a loan if you have a low downpayment or you can't accurately document your income.
In the case of home loans, the subprime borrowers you're hearing about these days are defaulting because market conditions have made their mortgages more expensive. Many people with adjustable-rate loans have seen their rates jump as other short-term interest rates have risen, pushing up their monthly payments. Others took out loans with teaser rates hoping they could refinance into better loans. When they couldn't because their income fell or their home's value declined, they got stuck with mortgage payments they couldn't afford.
