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Subprime Loans

Subprime Loans

Definition

Loans on residential real estate carrying interest rates that are substantially above the prime mortgage loan rate. Subprime loans are made to borrowers who pose a high credit risk, because they have either (1) a low credit score or (2) a high debt-to-income ratio. Often, subprime loans carry relatively low interest rates during the first 2 to 3 years of the agreement but then increase sharply thereafter, which, in some cases, causes the monthly payment to double or even triple. Beginning in 2006, falling national real estate prices combined with "resets" to higher monthly payment amounts, triggered numerous subprime mortgage loan defaults by borrowers. This, in turn, caused huge earnings losses for the banks that made subprime loans. Ultimately, the directors and officers of these banks were hit with literally hundreds of class action lawsuits by investors, who alleged that the directors and officers had been negligent in making such loans.

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