Subprime

Subprime lending
Is the practice of extending credit to borrowers with certain credit characteristics -- e.g. a FICO score of less than 620 -- that disqualify them from loans at the prime rate(hence the term 'subprime'). Subprime lending covers different types of credit, including mortgages, auto loans, and credit cards. Since subprime borrowers often have poor or limited credit histories, theyare typically perceived as riskier than prime borrowers. To compensate for this increased risk, lenders charge subprime borrowers a premium. For mortgages and other fixed-term loans, this is usuallya higher interest rate; for credit cards, higher over-the-limit or late fees are also common. Despite the higher costs associated with subprime lending, it does give access to credit to people whomight otherwise be denied. For this reason, subprime lending is a common first step toward “credit repair”; by maintaining a good payment record on their subprime loans, borrowers can establish theircreditworthiness and eventually refinance their loans at lower, prime rates.

Subprime lending became popular in the U.S. in the mid-1990s, with outstanding debt increasing from $33 billion in 1993 to$332 billion in 2003. As of December 2007, there was an estimated $1.3 trillion in subprime mortgages outstanding.[1]20% of all mortgages originated in 2006 were considered to be subprime, a rateunthinkable just ten years ago. This substantial increase is attributable to industry enthusiasm: banks and other lenders discovered that they could make hefty profits from origination fees, bundlingmortgages into securities, and selling these securities to investors.

These banks and lenders believed that the risks of subprime loans could be managed, a belief that was fed by constantly rising homeprices and the perceived stability of mortgage-backed securities. However, while this logic may have held for a brief period, the gradual decline of home prices in 2006 led to the possibility of...