What is a sub-prime mortgage?

The world is wallowing in the tidal wave caused by the sub-prime mortgage market crisis. What exactly is it? Subprime mortgage loans have higher rates than equivalent prime loans. Lenders consider many factors in a process called "risk-based pricing" when they come up with mortgage rates and terms. This makes it impossible to generalize about subprime rates. They are higher, but how much higher depends on factors such as credit score, size of downpayment, and what types of delinquencies the borrower has in the recent past. From a mortgage lender's standpoint, late mortgage or rent payments are worse than late credit card payments.

A subprime mortgage loan also is more likely to have a prepayment penalty, a balloon payment, or both. A prepayment penalty is a fee assessed against the borrower for paying off the mortgage loan early, either because the borrower sells the house or refinances the high-rate loan. A mortgage with a balloon payment requires the borrower to pay off the entire outstanding amount in a lump sum after a certain period has passed, often five years.

If the borrower can't pay the entire amount when the balloon payment is due, he has to refinance the loan or sell the house. And that’s exactly what happened.

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