Many borrowers who think they can only qualify for a Sub prime loan may very well qualify for FHA financing. FHA financing does not just look at a borrowers credit score. Instead it looks at the overall credit picture to determine eligibility. FHA home loans have rates that are very close to a conforming loan.
Another major difference between Prime mortgages and High Risk mortgages is the length of time of the prepayment penaly. With High Risk mortgages, most lenders know how desperate you are and are able to have a 1-3 year hard prepay penalty. (A hard prepay penalty is one where even if you sell the house in 1-3 years you still will have to pay a fee to close out the mortgage).
Most, if not all, Prime mortgages do not have a prepay penalty.
One of the biggest differences between qualifying for a Prime Loan vs. a High Risk Loan is your credit score. Borrowers with FICO Credit Scores of 720 FICO to 850 FICO are much more likely to be elgible for a Prime Loan vs. a High Risk Loan.
Although subprime mortgages are much more costly than prime loans, many home buyers with blemished credit history use these non-prime loans to re-build their credit profiles. After making timely payments for a couple of years, many homeowners see their scores increase dramatically, allowing them to refinance into prime mortgages with much lower interest rates.
Prime and sub prime lenders differ in the types of loans they offer. Prime lenders offer loans to those with credit scores of a certain minimum. Sub prime lenders provide loans to everyone else. Sometimes though, financing companies offer both types of financing.
Sub prime loans have higher rates and fees since the risk is higher for lenders. Reasonable lenders will only charge a couple of points higher for most types of loans.
High Risk mortgages will have higher margins than Prime mortgages. Most High Risk mortgages are ARM (Adjustable Rate Mortgage) based programs. These can start to fluctuate in a particular period of time. These ARM loans are made up of different components: the index, the margin, a floor and a ceiling.
The adjusting part of the loan is based on the index. This can be the LIBOR, the 12 month Treasury Average, the 6 month Treasury Average, the COFI, the COSI, or other numerous indices. The margin is how the bank makes its money. The floor is what the loan can never fall below. For High Risk mortgages, the floor is mostly the start rate of the loan. For Prime mortgage, the floor could drop all the way to the margin. Lastly, there is the ceiling. This is the highest to which the loan can go.