To access this increasing market, lenders often take on risks associated with lending to people with poor credit ratings or limited credit histories. For example, they would lend money to consumers that have bad credit. The FICO score indicates to the lender the rate of default. Those with credit scores below 620 have a much higher default rate than those with credit score above 720. However, if a borrower has sufficient income then he or she may qualify for a subprime mortgage product. Subprime loans are considered to carry a far greater risk for the lender due to the aforementioned credit risk characteristics of the typical subprime borrower. Lenders use a variety of methods to offset these risks. In the case of many subprime loans, this risk is offset with a higher interest rate. In the case of subprime credit cards, a subprime customer may be charged higher late fees, higher over-the-limit fees, yearly fees, or up-front fees for the card. Late fees are charged to the account, which may drive the customer over their credit limit, resulting in over-the-limit fees. These higher fees compensate the lender for the increased costs associated with servicing and collecting such accounts, as well as for the higher default rate.
Subprime loans can offer an opportunity for borrowers with a less-than-ideal credit record to become a home owner. Borrowers may use this credit to purchase homes, or in the case of a cash-out refinance, finance other forms of spending such as purchasing a car, paying for living expenses, remodeling a home, or even paying down on a high-interest credit card. However, due to the risk profile of the subprime borrower, this access to credit comes at the price of higher interest rates, increased fees and other increased costs. Subprime lending (and mortgages in particular) provides a method of "credit repair"; if borrowers maintain a good payment record, they should be able to refinance into mainstream rates after two to three years. In the United...