subprime mortgage

subprime mortgage, a type of home loan extended to individuals with poor, incomplete, or nonexistent credit histories. Because the borrowers in that case present a higher risk for lenders, subprime mortgages typically charge higher interest rates than standard (prime) mortgages.

The most common type of subprime mortgage contract offered in the United States is the adjustable rate mortgage (ARM), which charges a fixed interest rate for an initial period and a floating interest rate thereafter. The floating rate may be based on an index such as the federal funds rate, which is the rate at which banks lend money to each other overnight.

The sharp increase in subprime lending that occurred in the United States beginning in the late 1990s was primarily fueled by subprime mortgages. According to the Federal Reserve, the share of subprime mortgages among all home loans in the country increased from about 2.5 percent per year in the late 1990s to about 15 percent per year in 2004–07. One reason for the increase was aggressive marketing by mortgage brokers, who were paid commissions on the basis of the quantity, not the quality, of the loan contracts they sold.

The overuse of subprime mortgages and their widespread securitization was one of the primary factors that triggered the financial crisis of 2007–08 and the subsequent Great Recession (2007–09) after the demand for housing reached a saturation point in the United States in late 2007. As house prices plateaued, many subprime borrowers found themselves with houses they could not sell and with mortgages they could no longer afford. As they began to default on their loans and nationwide foreclosure rates hit record highs, banks and other lending institutions became less willing to lend to risky borrowers. As a result, subprime mortgages lost the wide popularity that they had once enjoyed among lenders in the United States.