Home loans designed for these types of high-risk borrowers are considered subprime or subprime mortgages.
The term subprime might sound familiar thanks to the subprime mortgage crisis. Prior to 2008, mortgage lenders had much looser standards for approving borrowers with poor credit scores and financial histories. These were also sometimes called no-doc loans because some lenders did not require documented proof of income.
Eventually, many of these borrowers defaulted on their loans. Between 2007 and 2010 foreclosures skyrocketed and banks lost tons of money, forcing the government to bail out many big banks, while others merged or were sold off in failure.
In response to the subprime mortgage crisis, the Dodd-Frank Act of 2010 was established to overhaul financial regulations to prevent a similar crisis in the future. The law includes a lender requirement called the Repayment Capacity Rule (ATR). This rule requires mortgage lenders to establish a thorough process to assess whether a borrower is able to repay the loan on their terms, virtually ending the practice of no-doc mortgages.
Lenders must also underwrite loans according to the standards outlined by Dodd-Frank. Failure to comply with these requirements may result in prosecution or other regulatory action. Additionally, subprime borrowers are required to attend homebuyer counseling provided by a representative licensed by the U.S. Department of Housing and Urban Development (HUD).