Subprime Lending - Defining Subprime Risk

Defining Subprime Risk

The term subprime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers. As people become economically active, records are created relating to their borrowing, earning and lending history. This is called a credit rating, and although covered by privacy laws the information is readily available to people with a need to know (in some countries, loan applications specifically allow the lender to access such records). Subprime borrowers have credit ratings that might include:

• limited debt experience (so the lender's assessor simply does not know, and assumes the worst), or
• no possession of property assets that could be used as security (for the lender to sell in case of default)
• excessive debt (the known income of the individual or family is unlikely to be enough to pay living expenses + interest + repayment),
• a history of late or sometimes missed payments (morose debt) so that the loan period had to be extended,
• failures to pay debts completely (default debt), and
• any legal judgments such as "orders to pay" or bankruptcy (sometimes known in Britain as county court judgements or CCJs).

Lenders' standards for determining risk categories may also consider the size of the proposed loan, and also take into account the way the loan and the repayment plan is structured, if it is a conventional repayment loan, a mortgage loan, an endowment mortgage, an interest only loan, a standard repayment loan, an amortized loan, a credit card limit or some other arrangement. The originator is also taken into consideration. Because of this, it was possible for a loan to a borrower with "prime" characteristics (e.g. high credit score, low debt) to be classified as subprime.