When talking to a friend I realized most people think subprime lending is the lending of money below the prime rate. The prime rate has nothing to do with this term. I just thought I would remind everyone what it is since the media seems to think it will cause our economy to collapse.
Subprime lending (also: B-Paper, B-tier, non-prime, near-prime, special finance, second chance lending) describes a specific lending market sector. Typically, subprime customers are those who do not qualify for prime market rates because of blemished or limited credit. Consequently, subprime customers are charged a higher interest rate to compensate for the increased risk. The general lending philosophy can be described as “priced to risk” where the interest rate the borrower pays increases as their risk level to the lender increases (but this is limited by the maximum annual interest rate as defined by law in each respective country).
The term “subprime” is not derived from the prime interest rate; in fact the borrower of a subprime loan incurs interests rates much higher than the prime rate.