Subprime Lending

Subprime lending is a financial term that involves financial institutions providing credit to borrowers who do not meet prime underwriting guidelines. Subprime borrowers have a heightened perceived risk of default, such as those who have a history of loan delinquency or default, those with a recorded bankruptcy, or those with limited debt experience.

This last class of mortgages has grown particularly popular among subprime lenders since the 1990s. Common subprime hybrids include the "2-28 loan", which offers a low initial interest rate that stays fixed for two years after which the loan resets to a higher adjustable rate for the remaining life of the loan, in this case 28 years. The new interest rate is typically set at some margin over an index, for example, 5% over a 12-month LIBOR. (The London Interbank Offered Rate, or LIBOR, is a daily reference rate based on the interest rates at which banks borrow unsecured funds from banks in the London wholesale money market.)

People got lured into buying houses at very low interest rates and little, or no money down. The radically higher interest rates kicked in after two years which would be covered by higher real estate prices - which was fine if prices went up, but became unsustainable debts if prices dropped.