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A High-Cost Home Loan—What You Need to Know

A high-cost loan is one with higher mortgage rates and fees when compared to conventional or government-backed home loans. A high-cost loan is typically associated with a subprime loan but may also be a loan for someone with decent credit but for some reason may not otherwise qualify for a mortgage. A high-cost loan and subprime loan really never had an official definition but last year the Consumer Financial Protection Bureau, or CFPB, laid out specific guidelines on whether or not a loan is considered high cost. These guidelines are in addition to those in the Homeowners Equity Protection Act, or HOEPA.

Lenders can issue high- cost loans but the CFPB has defined what is considered high cost and what is not. A high-cost mortgage is—

A first lien that has an annual percentage rate that is 6.5% higher than the average prime rate, rates reserved for those who can qualify for a conventional mortgage.
A loan is considered high cost if the loan is at least $20,000 with points and closing costs that exceed 5.00% of the loan amount. For example, if points and fees on a $25,000 loan add up to $1,500, or 6.00% of the loan amount, the loan is high cost.
A second lien that has an annual percentage rate of more than 8.5% higher than the average rate for a second mortgage reserved for those with good credit.
A loan that is less than $20,000 with points and fees that exceed 8.00% of the loan amount.

If a loan is considered high cost, the lender isn’t prohibited from making the loan but must follow additional guidelines. For example, prepayment penalties are banned. The loan cannot have a balloon feature which causes the loan to be paid in full before the loan term.

Who would want a high-cost loan in the first place? A high-cost loan is designed only as a temporary fix to a temporary problem. Say that someone has a credit score of 520 but has a 30% down payment. A conventional mortgage can’t be used due to the credit score but a high-cost loan might be an answer. If the lender can document the circumstances that caused the credit score to fall and the borrowers can afford the new monthly payment with the higher rate, a loan can be issued allowing the borrowers to buy a home while repairing credit. 

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