The “Subprime Mortgage Meltdown” and similar catch phrases have been all over the news lately and I’m sure there are more than a couple of you out there thinking, what in the world does subprime mean exactly?

Well, that’s a tough question to give a simple answer to, but I’ll do my best.

Borrowers are generally classified under two main categories, subprime and A-paper. Most simply, a subprime borrower is a borrower who’s credit (FICO) score is below 620; however, there’s some grey area that should be clarified.

Get Classified As A Subprime Borrower Lickety Split

Even if a borrower has a FICO score above 620, he/she may still be classified as subprime because of other factors. Some of the factors that cloud the definition of subprime are the following:

1. Late or missed mortgage payments in the past 12 months
   • Having late/missed mortgage payments in the past 12 months (at least 30 days late) is the easiest way to put yourself into the subprime category, even if your FICO score is excellent. There are very few A-paper lenders that will even consider lending to someone with even one late/missed mortgage payment in the past 12 months unless that borrower has other compensating factors, such as very high income ($10,000+) or very low LTV (Loan-To-Value: Ratio which describes the relationship between the desired loan amount and the value of the house). In layman’s terms, if you have even one late/missed mortgage payment in the past 12 months, you’ll only be able to qualify for the best rates if you make a lot of money, have otherwise impeccable payment history, low LTV and little debt. Even if you meet these conditions, you’ll be hard-pressed to find an A-paper lender that will give you the best rates available (I know of one right now).
2. High LTV:
   • LTV is an abbreviation of Loan-To-Value and represents the ratio between the desired loan amount and the present value of your house. If your LTV is above 80% you’ll have a hard time getting the best rates, although with a good mortgage broker you may still swing it. Once you get over 90% you drop into what’s called “Alt-A”, which describes the grey area between A-paper and subprime and is the classification reserved for borrowers with excellent credit histories, but less than desirable loan terms. The bank equates high LTV with high risk because in the event the bank has to foreclose on your home, there will be very little equity remaining to prevent the bank from losing money. For example, if your house is worth $300,000 and you get a loan of $298,000 and then foreclose, the bank will lose money if it has to go through the steps to sell the house at a discounted price at auction. The bank may only get $240,000 at auction if the house is in perfect condition, so before expenses, it’s already lost $58,000 ($298,000 loan amount – $240,000 sale price). Because of this, you should expect your interest rate to be higher at LTVs above 80%, and especially above 90%. You’re not technically considered a subprime borrower, but you’re in the grey area called “Alt-A” between subprime and A-paper (don’t ask me why these classifications are named as they are).
3. Bankruptcies or foreclosures in the past 24 months
   • If you’ve had a bankruptcy or foreclosure in the past 24 months, you’re going to be considered subprime. If it’s been more than 24 months since you declared bankruptcy or foreclosed, you may or may not be considered subprime.
   • If, in addition to a bankruptcy or foreclosure in the past 7 years, you have late/missed mortgage payments in the past 24 months – note that this is different from the 12 month limit described in #1 above - you’ll be considered subprime.
   • If your bankruptcy or foreclosure was more than 7 years ago, most banks won’t consider it at all.
   • Ultimately, if you’ve declared bankruptcy or foreclosed in the past 7 years, it is vital that you not be late on or miss any mortgage payments or you’ll put yourself in a very bad position.

A Couple Other Subprime Tidbits

• Two or three late/missed mortgage payments in a row is better than two or three late/missed mortgage payments spaced a month or more apart.
• For bankruptcies, the time frames noted above refer the the time since the bankruptcy was discharged, not the time since the bankruptcy was first filed.

There are quite a few factors that go into figuring what rate a borrower qualifies for. It’s important to know these things beforehand because if you’re the victim of unfortunate circumstances, such as being laid off from your job, you’ll know how to best manage your finance if it gets down to crunch time.

Become Educated On Your Finances

One more thing, bankruptcy was created to prevent the stifling of entrepreneurship, so I’m all for its existence, but if you’ve been through bankruptcy or foreclosure and you’re consistently missing mortgage payments, you need to educate yourself on personal finance. It’s never too late to turn your finances around, so check out my post about books that changed my life for a fresh start.

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