Subprime loan

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A type of loan that is offered at an initial interest rate below the 'prime rate', which will then escalate later in the term of the loan, or mortgage. Quite often, borrowers are turned away from traditional lenders because of their low credit ratings or other factors that suggest that they have a reasonable chance of defaulting on the debt repayment. Subprime, escalating-rate loans are attractive to speculative borrowers and lenders as well, who may hope to re-sell a house for a profit (purchased with the subprime loan) after a quick appreciation in its market value, without the holders having gained equity through significant payment of the principal of the loan.

Subprime loans have an overall higher interest rate than the prime rate offered on traditional loans. The delayed additional percentage points of interest often translate to tens of thousands of dollars worth of additional interest payments, and slow repayment of the principal over the later life of a longer term loan. It is meant to compensate the lender for the additional risk of taking on a 'subprime borrower'.

Subprime loans represented about 20 per cent of the $3-trillion US mortgage market in 2006. Hundreds of billions of dollars' worth of subprime mortgages have been gathered together and resold as parts of bonds to hedge funds and banks all over the world. The buyers could use them as savings or collateral to secure more loans, so they could buy more bonds and so on and so on. The fact that real estate values did not continuously rise, and subprime mortgage payments became unaffordable to holders due to greatly rising payments over the term of their loans without increasing their equity, made a traditionally secure bond in real estate become insecure. Losses have been shared by all of buyers, sellers and resellers of these subprime loans and corresponding bonds, and the general economy due to the widespread practice.

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