Subprime Mortgage Loans-Why Choose Them When You Don’t Have To?

In today’s market, subprime mortgage loans – high-risk mortgages that charge a higher interest rate in order to compensate for a borrower’s blemished credit record – often seem to be the only choice for someone with a low credit score or late payments who is looking for mortgage solutions. The truth is that there are programs in place that are offered by certain lenders that give this type of borrower another option. One such option, an Alt-A loan program, gives borrowers with less-than-perfect credit scores a chance to take advantage of many of the benefits that are offered to those who do qualify for the standard “prime” loan.

What are Subprime Mortgage Loans?

Subprime mortgage loans may at first seem like an appealing option to a borrower. He may have previously been told that he did not qualify for a mortgage at all, closing the door to his dream of becoming a homeowner. In some instances, he may then turn to a subprime lender, who can offer a way for him to achieve his goal after all. Subprime mortgage loans were created to give borrowers who may be considered “high risk” an opportunity to own a home. However, many subprime lenders are of the philosophy “Do Less, Make More.” They are simply out to sell their product, and they either can’t or won’t offer the borrower another option, even though other alternative mortgages do exist.

While subprime mortgage loans are offered to borrowers who may have what are considered to be red flags on their credit report, they bring many negatives to the table. Because they are high-risk mortgages, they have higher interest rates and higher closing costs that compensate the lender for its perceived risk in taking on this type of borrower. In addition, many borrowers of subprime mortgage loans will find, when it is time to pay taxes or insurance on their property, that they do not have an escrow account where funds are accrued to pay these items. You would think that a loan made to a person that has shown an inability to make payments on time and handle their finances prudently would mandate escrow accounts. The borrowers may find that they must refinance their loan in order to cover those taxes or insurance. However, prepayment penalties are customary on such high-risk mortgages, leaving a borrower in this scenario in more debt than when he started the process.

In addition, lenders offering such high-risk mortgages will typically not agree to a locked-in price until the day of the closing. This means that the borrower loses out on price protection against the market and may wind up being forced to pay an even higher interest rate on their subprime mortgage loans than was previously discussed.

An Alt-A Loan Program: The Alternative to Subprime Mortgage Loans

So are there other options for borrowers with problematic credit histories beyond subprime mortgage loans? Yes – and one such option is an Alt-A loan program. This alternative to other high-risk mortgages is offered by many lenders and can give certain borrowers another choice when seeking mortgage solutions. Borrowers with a credit score of 600 to 660, who may have a late payment or two in their history, and who have a debt ratio of around 50% (where standard loans require 40%), are likely to be eligible for this type of program.

With an Alt-A loan program, unlike other high-risk mortgages, prepayment penalties are not mandatory, leaving open the ability to refinance more easily at a later time. Lower interest rates than those offered by a subprime lender are available to borrowers, and closing costs are typically lower than subprime loans as well. Even better for the borrower, an Alt-A loan program offers a wider range of payment stream options, from interest-only loans to 40-year terms to buy downs, which can enable the borrower to buy a bigger house than he or she previously thought possible.

Plus, a lender offering an Alt-A loan program will normally offer a longer guaranteed lock period and will even put the rate in writing for a certain period of time. This allows borrowers to know up front just to what they are committing. This can make a very big difference throughout the term of the mortgage, particularly if the borrower does need to refinance at some point in the future, and makes this a better option than subprime mortgage loans and other high-risk mortgages.

Choosing a Lender for Alt-A Mortgages

It is critical to work with a full-service lender that offers a wide range of diverse mortgage solutions, including Alt-A mortgages, rather than one that specializes in just prime or just subprime mortgage loans. This way, borrowers can be sure that they are offered the program that is best for their needs, not the program that is best for the lender’s needs. In addition, before committing to working with any lender, the borrower and the mortgage broker should both feel confident that the lender has the resources and the knowledge to answer all questions about alternative mortgages and handle all concerns.

Above all, borrowers should never feel pressured into choosing subprime mortgage loans simply because of their credit history. They should instead be made aware of all of the programs that exist. While subprime mortgage loans may turn out to be a borrower’s best bet for home ownership, he or she should be able to make that decision comfortably after exploring all other options for high-risk mortgages. And by understanding the benefits of an Alt-A loan program, borrowers may find that in fact they can have a mortgage with a better interest rate and better protections than previously thought possible.

Fixed, Tracker Or Discount – Which Mortgage Rate is Best?

The choice of whether a fixed rate, variable, discounted, capped or tracker rate mortgage is more appropriate to your needs, will take careful consideration. The article that follows provides a breakdown of the individual rates with their advantages and disadvantages as based on your attitude to risk, not all types of mortgage will be suitable.

When considering which type of mortgage product is suitable for your needs, it pays to consider your attitude to risk, as those with a cautious attitude to risk may find a fixed or capped rate more appropriate, whereas those with a more adventurous attitude to risk may find a tracker rate that fluctuates up and down more appealing.

Following is a description of the different mortgage rate options along with a summary of the main advantages and disadvantages for each option.

Fixed Rate Mortgages

With a fixed rate mortgage you can lock into a fixed repayment cost that will not fluctuate up or down with movements in the Bank of England base rate, or the lenders Standard Variable Rate. The most popular fixed rate mortgages are 2, 3 and 5 year fixed rates, but fixed rates of between 10 years and 30 years are now more common at reasonable rates. As a general rule of thumb, the longer the fixed rate period the higher the interest rate. Similarly lower fixed rates are applicable when the loan to value falls below 75% whereas mortgages arranged for 85% or 90% of the property value will incur a much higher mortgage rate.

Advantages

Having the peace of mind that your mortgage payment will not rise with increases in the base rate. This makes budgeting easier for the fixed rate period selected, and can be advantageous to first time buyers or those stretching themselves to the maximum affordable payment.

Disadvantages

The monthly repayment will remain the same even when the economic environment sees the Bank of England and lenders reducing their base rates. In these circumstances where the fixed rate ends up costing more, remembering why the initial decision was made to select a fixed rate, can be helpful.

Discount Rate Mortgages

With a discount rate mortgage, you are offered a percentage off of the lenders Standard Variable Rate (SVR). This takes the form of a reduction in the normal variable interest rate by say, 1.5% for a year or two. Assuming that the higher the level of discount offered the better the deal is a common mistake of those considering a discount rate. The key bit of information missing however, is what the lenders SVR is, as this will dictate the actual pay rate after the discount is applied.

As with a fixed rate, the longer the discount rate period the smaller the discount offered, and the higher the rate. Shorter periods such as 2 years will attract the highest levels of discount. In addition when considering the amount to be borrowed, the increased risk to the lender of providing a 90% loan will be reflected in the pay rate, with lower borrowing amounts attracting more competitive rates.

Advantages

Should the lender reduce their standard variable rate your interest rate and monthly payment will also reduce.

Disadvantages

When the lender or Bank of England increases their base rate, your mortgage payment will also increase. However in some circumstances lenders do not always pass on the full amount of a Bank of England base rate reduction.

Affordability of the mortgage at the end of the discount rate period should be considered at outset. There are no guarantees that follow on rates will be available, and so you should make certain that you are able to afford the monthly payment at the lenders standard variable applicable upon expiry of the discount rate period. Allowing for an increase in interest rates above the SVR would be prudent to avoid a ‘Payment shock’.

Tracker Rate Mortgages

Tracker rate mortgages guarantee to follow the Bank of England base rate when it moves up or down. Tracker rates are expressed as a percentage above or below the Bank of England base rate such at +0.5% over BOE base rate for 2 years.

The most popular tracker rate mortgages have been 2 and 3 year products, but there is now an increasing demand for lifetime tracker rates as borrowers are starting to realise that the Bank of England base rate has been reasonable competitive, and having a mortgage product linked to it could be beneficial in the long term.

Advantages

A tracker rate guarantees to follow the Bank of England base rate for however long the tracker rate is set up for. This means a tracker rate mortgage payment reduces in line with reductions to the base rate by the Bank of England.

The overall cost calculation of a Lifetime tracker rate can be significantly lower than taking shorter term mortgage products with the ongoing costs of remortgaging such as valuation fees, legal fee and lender arrangement fees. Lifetime tracker rates often have no early repayment penalty restrictions.

Disadvantages

The mortgage payment will go up if the Bank of England increases the base rate. As with most other types of mortgage, early redemption penalties will apply for some or all of the tracker rate period and are typically 5% of the loan or six months interest.

Variable Rate Mortgages

Variable rate mortgages are more commonly known as the lenders Standard Variable Rate (SVR), and are the rate that you come onto after the expiry of a fixed, discounted, tracker or capped rate mortgage. A variable rate is similar to a tracker rate in as much as the lender will base their SVR on the Bank of England base rate plus a loading of between say 2.5% and 3.5%. That is where the similarity ends however.

Advantages

The main advantage of being on the lenders Standard Variable Rate (SVR) is that there will be no early repayment charge for redeeming the loan in full. When there is uncertainty about rate movements in the financial markets, this can provide a degree of certainty and flexibility. For those wishing to fix their mortgage rate, an SVR with no early repayment charge can provide the breathing space required to just wait and see before committing.

Historically not all lenders have chosen to pass on through their standard variable rates, reductions made by the Bank of England. This situation is changing and those with SVR mortgages benefit from a reduced payment.

Disadvantages

Generally the SVR will be a higher rate of interest and so your mortgage payment will be greater than if you were on a tracker rate, fixed rate or discounted rate mortgage product. Additionally and in comparison to other types of mortgage, a higher monthly payment can result when lenders do not pass on any or all of a reduction in the Bank of England base rate which has not been uncommon in the past.

Capped Rate Mortgages

The capped rate is a variable rate mortgage which has a fixed limit to how far the interest rate can increase (the cap), and provides the option to know the maximum level of mortgage payment from outset. For those who are risk adverse, but who wish to have the certainty of payment as well as benefit from interest rate reductions, the Capped rate mortgage offers the best of both worlds. For example if the cap is set at 6% and the banks rates go below this rate, then your repayments will go down to reflect the reduction, with the guarantee that should rates go above the 6%, your payments will remain based on the maximum 6% because of the cap.

Advantages

If the Bank of England base rate falls resulting in a fall in the lenders standard variable rate below the level of the capped rate, then your monthly repayment will reduce. For many this provides the peace of mind and certainty for ease of budgeting offered by a know maximum monthly payment.

Disadvantages

Because a capped rate offers the best of both worlds to the borrower, the capped rate is usually uncompetitive as lenders need to price in the risk of rate reductions, leaving those such as first time buyers or those stretching their affordability, exposed to a higher rate than would be available with a fixed rate. This means that competitive capped rates are seldom available with UK lenders who prefer to offer fixed rates instead.

Mortgage Rate Arrangement Simplified?

When looking for a mortgage, it’s essential to understand the different products that are available so you can be sure you get the right one for you. Lenders offer different interest rate options and this will affect your monthly payments. So choosing the right deal could save you money.

With so many product choices available it is essential you get professional indepenedent advice.

Types of mortgage products available:

Standard Variable Rate Mortgage

With this mortgage, your payments will go up and down as the lender’s standard variable rate goes up or down. Usually any changes in the lenders variable rate will be in line with movements in the Bank of England base rate. The Bank of England Monetary Policy Committee reviews this rate on a monthly basis.

Is it right for me?

Yes – if you can afford to pay more when mortgage interest rates go up and want to take advantage of lower payments if rates fall.

No – if during the early years you would be unable to cope if repayments increased because of rising interest rates.

Base Rate Tracker Mortgage

This is similar to a variable rate mortgage. But the interest rate will go up and down exactly in line with any changes in the Bank of England base rate. Your mortgage payments will go up and down too as the interest rate changes. The tracker period is usually for a specified time, which can be from one year up to the lifetime of the mortgage loan. At the end of the tracker period, your mortgage interest rate will change to the lenders standard variable rate. This product may carry an early repayment charge.

Is it right for me?

Yes – if you want to be sure your mortgage rate falls by the same amount as the Bank of England base rate falls, but the drawback is the mortgage rate also rises in step when the base rate increases.

No – if you find yourself locked into a rate above the base rate, which may be higher than the standard variable rate.

Fixed Rate Mortgage

Your mortgage interest rate is fixed for a set period only, during which your mortgage payments will stay the same. At the end of the fixed rate period, your mortgage interest rate will change to the lender’s standard variable rate. Fixed rate mortgages are usually available for between one and ten years, however they can be available for longer periods depending on market conditions. This product may carry an early repayment charge.

Is it right for me?

Yes – if you need to budget with certainty for the next few years, or you think mortgage interest rates will rise, or both.

No – probably not if you think mortgage interest rates will fall.

Discounted Rate Mortgage

The lender offers a discount off their standard variable rate for a set period, normally one or two years. Your mortgage payments will still vary in line with changes in the standard variable rate. At the end of the discount period, your mortgage interest rate will be the same as the lender’s standard variable rate. This product may carry an early repayment charge.

Is it right for me?

Yes – if money is tight when you first take out the mortgage, but you’re confident your income will increase.

No – if you won’t be able to cope if interest rates rise later on, increasing your payments.

Capped & Collar Rate Mortgages

With a capped rate mortgage the interest rate can go up or down in line with movements in the lender’s standard variable rate, but cannot go above a set upper limit, known as the ‘cap’ or ‘ceiling’. This type of mortgage can also have a set lower limit, known as the ‘collar’. For these mortgages the interest rate can move between these limits but cannot fall below the collar or go above the cap. This product may carry an early repayment charge.

Is it right for me?

Yes – if you like to budget with some certainty, think mortgage interest rates might rise above the cap, or you want the security of knowing your payments cannot rise above a set level and would like to benefit from any fall in interest rates.

No – if your mortgage adviser can find a fixed rate set at a lower rate than the capped rate, and you think rates are unlikely to fall below the level of the fixed rate deal.

Cashback Mortgage

The lender pays you a cash lump sum after completion, which you can use for any purpose. This product may carry an early repayment charge.

Is it right for me?

Yes – if you need a cash lump sum, for example to do up your home, or you expect the cashback to more than compensate for any rises in interest rates during the period when an early repayment charge may apply.

No – if you can manage without a cashback now and can get an alternative deal.

Remember your home may be repossessed if you do not keep up repayments on your mortgage.