Subprime lending practices rise
Kian Hagerman
The U.S. subprime mortgage crisis that began in 2008 led to the eventual recession that still affects the country, but the lending practices of many institutions prior to the crisis are re-emerging.
According to Michael Simkovic, Associate Professor of Law at Seton Hall Law School, subprime mortgages increased from approximately 7-8 percent of the market in 2000 to 2003, to approximately 18-20 percent in 2004 to 2006.
Many college students attempting to secure a loan qualify as subprime, due to their credit history.
Subprime lending involves making loans to people that could have difficulty making scheduled payments, usually those with a credit bureau risk score (FICO) of 660 or less according to the FDIC.
To compensate for the increased risk of loss, as well as the dubious prospect of profit, lenders offer higher interest rates as well as other unfavorable terms to those receiving subprime loans.
Conversely, those with higher credit ratings are considered prime borrowers, and receive various benefits not available to subprime borrowers.
MCC economics intructor Philip Benson said, “It’s not a good or bad thing, it’s just the reality. The higher the default risk, the higher the interest rates will be.”
One area where subprime lending has seen an increase is in auto loans; according to Experian Automotive the year over year change in risk distribution of open automotive loans has increased the greatest in loans rated subprime or below.
“If you see zero percent financing on a vehicle that is well below what is normal,” Benson said.
“Manufacturers are paying part of the interest. They cut the price of the car.”
Benson added that all the best deals go to prime borrowers. “If you are prime, from the lender’s standpoint you are low risk.” Benson said.
There are both costs and benefits involved with taking out any loan, subprime loans included.
“There is good and bad; on the good end a subprime loan allows someone with no credit history or bad history to have access to credit,” said Brian Dille, a political science instructor at MCC. Dille added that there is risk involved with taking out subprime loans, and those unaware of the risk could encounter issues.
Leading up to the 2008 crisis, lenders offset the risk of subprime mortgages by packaging them as mortgage-backed securities, and then selling the securities to investors, many of whom were unaware of the related risk.
“Public interest lies when risk isn’t managed,” Dille said. “As long as the bank or card company is bearing all their risk there is no problem.”
Subprime mortgages are necessary for many, and borrowers can mitigate some of the risk associated with such loans by being informed about the terms they accept.
