The subprime mortgage crisis has dominated the headlines since the summer of 2007. What began as a limited problem affecting high-risk— or subprime — mortgage borrowers in the U.S. has rippled throughout the world financial markets.
Subprime loans are generally made to borrowers who have weak credit histories. Unlike prime loans, which are available at competitive market rates to people with good credit, subprime loans are offered at several percentage points above the prime interest rate to compensate lenders for the greater risk they take in making the loans.
Most of the subprime loans now facing default are adjustable-rate mortgages (ARMs). Federal agencies define subprime ARMs as having one or more of the following features:
Low initial introductory rate for a short period, which then adjusts to a variable rate several points above the prime rate for the loan’s term
No limits — or very high limits — on how much the monthly payments or interest rate can increase when the loan resets
Little or no documentation of borrower’s income required
Substantial prepayment penalties or prepayment penalties after the introductory period
Other features that would result in frequent refinancing to secure an affordable monthly payment
