When people who dont have stellar credit ratings need loans, they often have to depend on lenders that offer less-than-ideal conditions to get the money they need. While this scenario almost always benefits the lender at the expense of the borrowers savings and credit standing, subprime loans are sometimes a borrowers only resort.
Essentially, a subprime loan is a loan offered at a rate above prime. These loans are granted to people whose credit ratings dont qualify them for prime rate loans because they have low credit scores or other issues. Such issues make traditional lenders believe that the borrower may default on the loan.
Although subprime loans arent usually in the best interest of the borrower, there are occasions when obtaining this type of loan is necessary. Some of the advantages of subprime loans are that they:
However, these loans are often described as "predatory loans" because they
While different people assign various definitions to what predatory lending is, it can be loosely defined as a type of lending that involves targeting and convincing borrowers to take a loan with poor conditions. Essentially, the lender has information about how the loan will play out and the borrower does not.
The reason subprime loans and predatory lending are closely linked is because people with low income or bad credit are often taken advantage of by lenders. When the economy is sluggish, many people who have no other options take out subprime mortgage loans (to buy a home) and subprime personal loans (to pay off higher interest debts). Because these borrowers typically have low credit ratings and need money, they are easy targets for unscrupulous lenders.
Predatory lending is heavily connected to three market conditions:
Predatory lending can also refer to granting loans that charge ridiculously high interest rates, such as payday loans, or loans that place borrowers at high risk for default. This often occurs with negative amortization mortgages because borrowers make extremely low monthly payments while the outstanding balance continues to grow over time.
Part of the reason so many home foreclosures occur is because lenders know that borrowers who took out subprime personal loans are stuck in them and are likely to default on payments. This leads to foreclosure and, in some cases, bankruptcy.
The smart consumer will do research to make sure hes not being taken advantage of by lenders. Some warning signs of a predatory loan include:
Even if youre a consumer with a poor credit rating or a low-income, be sure to identify all of your options so that you dont get caught in the trap of predatory lending. Predatory lending will only hurt your credit score and will likely cost you more money than you can afford to repay.
If a lender tells you that hes your only option for obtaining a loan, pressures you to accept high-risk loans or encourages you to lie about income information in order to get a loan, he is most likely not helping you make a good deal for your financial situation.
Investopedia (n.d.). Subprime Loan. Retrieved March 17, 2008, from the Investopedia Web site.