Sub-Prime Mortgages...The Good, The Bad, The Ugly...

Sub-prime lending is a type of credit given to a homeowner who do not meet the criteria for regular or "prime" type loans. A typical sub-prime borrower has a poor or limited credit history and a FICO score below 620. These factors make them a risky investment for regular lenders, which keeps them from taking out loans. To compensate for the risk, sub-prime lenders impose higher cost on their contracts. For credit cards, this is usually a higher fee for over-the-limit spending or late fees. Sub-prime mortgages usually have higher interest rates and stricter terms.

Historically, sub-prime lending has not always been a perfectly legal business. From 2003-2007, sub-prime lending was subject to predatory lending practices by various shady lenders who turned up offering terms ranging from unfair to downright illegal. This along with the economic slowdown has contributed a great deal to the real estate crisis that forced many homeowners into foreclosure.

Not all sub-prime loans and lenders are bad. There are many who give you good value for your money. If you find a good lender and stay current, sub-prime lending can have its benefits. An example would be that some people use sub-prime lending to repair their credit and improve their FICO score. By keeping a good track record with sub-prime lending, it gives you the chance to eventually refinance to better terms.

Sub-prime loans have...higher costs,interest rates, origination fees, and closing fees, compared with prime type loans. Although the basic formula is the same, the higher costs are directly related to an increase in risk. Sub-prime loans also are noted for prepayment penalties. The prepenalty is usually associated with paying extra each month or paying off the loan early. This makes up for the lost interest on the lender's part. The lender will get heir fees one way or another.

Many sub-prime lenders follow the 2/28 structure. This means that you pay a fixed interest rate for the first two years, after which the loan switches to an adjustable rate where your payments are determined by market indicators. Often the introductory rate is higher than the current index and margin is applied once the loan shifts. For example, a lender can give you an intro rate of 8% while the index is currently at 4%, with the margins set at 6%. Assuming the index stays the same, your rate can jump to 10% when your two year is over.

There are laws in place to protect homeowners from predatory lending practices. Theses laws apply to any type of mortgage. The Real Estate Settlement Procedures Act (RESPA) requires all lender to give you a good faith estimate of the total cost of the loan before closing any deal. All mortgages are also covered under the Truth In Lending Act (TILA). This law gives you the right to know the full lending terms and loan costs in any credit transaction, including credit cards. TILA allows you to opt out of a transaction within a reasonable time period if you do not agree with some of the terms.

If a sub-prime mortgage has put you in financial difficulty, another option is loan modification. We have previously discussed loan modification in detail, but thee is one thing to add with relation to sub-prime that is an important thing to consider. As I mentioned earlier, sub-prime lending has been subject to numerous predatory lending practices over the years. If you are in financial trouble with your sub-prime mortgage, you would be wise to consider loan modification. At the same time, have your loan modification professional look at your original loan documents to see if there is any evidence of previous wrongdoing. Although a loan modification professional is not a legal person nor is authorized to give legal advice, often they can tell if something looks suspicious. If they see something unusual, they can refer that you contact and consult with an attorney that specializes in RESPA & TILA, who will review your case and advise you on the best course of action, whether to consider litigation against the lender or just to continue with the modification process...