Subprime Credit

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Subprime Credit

What Is Subprime Credit?

Subprime credit refers to loans issued to borrowers with bad credit that are often offered at rates significantly over the prime rate.

Key Takeaways

  • Subprime credit refers to loans issued to borrowers with bad credit that are often offered at rates significantly over the prime rate.
  • Subprime credit is sometimes the only sort of loan accessible to borrowers who have poor credit, high debt levels, a history of delinquency, defaults, or bankruptcy, and no property or assets to use as security.
  • Consumer advocates argue that subprime lending is a social benefit since it gives financing to low-income families, despite the fact that it raises the danger of credit booms and busts.

Understanding Subprime Credit

Subprime credit is sometimes the only sort of loan accessible to borrowers who have poor credit, high debt levels, a history of delinquency, defaults, or bankruptcy, and no property or assets to use as security. Lenders define subprime borrowers using a credit scoring system, such as FICO ratings, depending on the likelihood of payback. Varied lenders have different methods for determining what qualifies a subprime loan, although FICO scores below 619 have historically been regarded as subprime.

Subprime credit is funded by pooling subprime credit card debt, auto loans, business loans, and mortgages and selling them to investors as asset-backed securities such as CDOs and mortgage-backed securities (MBS).

Special Considerations

During the early 2000s housing bubble, lending requirements for subprime mortgages were eased, and NINJA loans were granted to borrowers with no income, no employment, and no assets. When the bubble broke in 2007, the amount of subprime credit in the financial markets led to the subprime collapse and crisis, which precipitated the Great Recession.

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Subprime lending, according to consumer advocates, is a social benefit that offers financing to low-income families. However, it raises the risk of credit booms and busts. Following the financial crisis, banks in the United States tightened lending rules.

Vehicle financing businesses, on the other hand, have leveraged low interest rates to drive a surge in subprime auto loans, which has aided the economy’s recovery. However, vehicle loan delinquencies reached crisis levels in 2017, even as subprime auto lending continued to rise, raising concerns that another credit bubble is forming and would eventually explode.

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