Recently, Wells Fargo Bank announced that it’s going to start allowing subprime loans again. Since Wells Fargo is the largest mortgage lender in the U.S., analysts concur that the move may help compensate for the significant national decrease in mortgage lending volume over the last several months.
Is this a good thing, or are subprime loans too high a risk for both lenders and financially-strapped borrowers? To understand the advantages and disadvantages, it’s important to have a clear understanding of exactly what a subprime loan is.
What is a Subprime Loan?
A subprime loan is a loan made to borrowers who, according to their credit history, financial/employment status or other issues, may have trouble meeting the payment schedule. Traditionally, borrowers who qualify for “subprime” status typically have a FICO score of below 640, although this can vary.
Subprime Loans: The Pros
• Subprime loans provide funding for people who otherwise wouldn’t be eligible for a loan. By allowing subprime loans again, Wells Fargo is making it possible for lower-income borrowers to take out loans for cars, homes, tuition and other necessities.
• Subprime loans can help borrowers get back on their feet. For those who have been hit hard by the financial recession, a subprime loan can help them pay off crucial debts and keep their head above water until they can get on more stable financial ground.
• Subprime loans will increase mortgage lending across the country, which is always good news for lenders.
Subprime Loans: The Cons
• Subprime loans have higher interest rates. You can compare it to car financing: if you have better credit, you can get better terms, but the worse your credit is, the higher your interest and monthly payments will be. A subprime loan works on the same principle.
• Subprime borrowers generally have poor collateral. This means that, in order to compensate for carrying a higher risk loan, lenders aren’t going to offer very good terms to subprime borrowers. In addition to higher interest rates, this can mean everything from stringent penalties to higher processing/administrative fees.
Over the next year, other banks are sure to be watching with interest to see if Wells Fargo’s subprime lending strategy succeeds, or whether it becomes a financial liability. If it’s successful, it’s a good bet that other banks will follow Wells Fargo’s lead, albeit cautiously. In the meantime, smaller-scale lenders are already following suit by offering debt consolidation loans to higher risk borrowers with low credit scores. If lenders continue this trend, analysts predict that this new type of subprime lending may become the wave of the future.
If you are looking for a mortgage and not sure if you qualify, you can check here to see what you qualify for.