What is sub-prime mortgage?

To understand sub-prime crisis we have to first know sub-prime mortgage.

‘Mortgage’ according to the American Heritage Dictionary is

“A temporary, conditional pledge of property to a creditor as security for performance of an obligation or repayment of a debt.”

Sub-prime lending/mortgage is characterized by the following:

1. Loans to borrowers with poor credit history, poor credit rating
2. Risky to both borrowers and lenders
1. Borrowers can get their security/collateral foreclosed
2. Lenders can lose the money they have lent
3. The higher risk is counter balanced by higher interest rate
4. ‘subprime’ is the credit status of borrower and not the interest rate

Generally the sub-prime lenders offer some incentives since they are charging higher interest rate. Some of the schemes in market are:

Interest Only Loans – Paying only interest during the initial years,
Adjustable Rate Mortgage (ARM) – Mortgage in which interest rate is periodically changed depending on an index.
Hybrid ARM – Rate is fixed for a period of time and floating.
Option ARM – Borrower has option of choosing either a minimum payment or an interest only payment.
Teaser Rate – Getting loan at an initial fixed interest rate for couple of year and then converting it into variable rate.
NINJA Loan – Mortgage given to a person with No Income, No Job, and No Assets.
Liar Loan – Mortgage provided without requiring documentation from borrower.
Balloon Payment Loan – Mortgage which has a large balance due at maturity.

In the next article we will discuss about the sub-prime crisis. :)