Subprime loans do come below prime loans as the rate of interest charged is far below in prime loans as compared to subprime loans. The customer with a bad credit history i.e. having a low credit score has no other option than to go for a subprime loan. The business banks won’t provide loans to them, so whenever they want to buy a house, they have to go for a subprime lender.
The rates of interest in subprime loans as it is a high risk loan is about 22% while the customer of good credit score does get the same loan with as low as 5 – 7 % of interest rate. Thus what happens that by paying 22%, the low credit score customers became poorer both money wise and credit wise. They have the last ray of hope their property which may have an increase in its value. So that they may sell the house and earn some profit and credit score for them.
The main concept behind reducing the risk factor is that the subprime lenders do not linger with the loan too long. They make up packages of different loans and sell them off to the reputed lending organization. Now what a package of loans does is that it reduces the risk involved in subprime loans. If there are one or two defaulters in the package, it would be negligible for the company as it is in a package where there are many customers which are not defaulters. It could be a big blow for a company if many of the customers in a package do become defaulters. This was what once happened with HSBC finance. Its share values in the stock market reduced significantly as the company estimated many bad loans. Well some financial advisers said that this is actually weakening the U.S mortgage business.