This is a form of lending to a category of people who might have a tough time keeping to the payment schedule. Because of either faulty credit history, low credit score or a lack of steady income, their ability to repay is in question.
To quantify, this is historically a category that is a FICO score of 600 or below. The risk to the lender increases along with the probability of default. For this reason, subprime loans tend to come with higher interest rates along with more upfront fees.
We see this type of lending for:
- homes
- automobiles
- consumer loans
The collateral also tends to be of poor quality.
In the era of securitization, we see loans broken into pieces, grouped together, and sold in a package. This was the case with subprime mortgages which ended up becoming a part of the mortgage-backed security crash during the Great Financial Crisis.
Reason For Subprime
- little to no debt experience
- limited property or assets that can be used as collateral on the loan
- defaulted debt in the past
- legal judgments such as bankruptcy
- history of late or missed payments
- likely not being able to pay all living expenses based upon income
There are other factors that can lead individuals to be classified as subprime even if they qualify as prime. The structure of the loan along with the originator can be factored in as well.