When the subprime mortgage crisis started making headlines, the public began learning more about instruments known as B/C loans. Simply put, B/C loans are for borrowers with  a poor credit history. Many banks and financial institutions simply won’t make B/C loans because they do not meet the minimum criteria used by those banks to approve borrowers.

In addition, B/C loans do not meet the requirements of Fannie Mae and Freddie Mac, so as you may expect, these loans carry a higher interest rate than so-called “A” loans. And because B/C loans are considered risky, fewer lenders offer them. That also means interest rates will be higher due to low competition among lenders for potential borrowers.

Purpose of B/C loans

Having a low credit score doesn’t necessarily mean you’re shut out of the home market. People who have had financial struggles in the past or who simply made a few poor choices that hurt their credit history, may now be in a position to make their payments without a problem. For them, a B/C loan may be the first step toward building a good credit score. B/C loans are often considered temporary loans that are in place until a borrower restores a better credit rating and qualifies for an A loan.

If you do get a B/C loan, and you’re looking to refinance to an “A” loan once your credit score improves, make sure there are no major pre-payment penalties. Some lenders include penalties to help dissuade borrowers from re-financing. Ideally, B/C loans should be paid off quickly so you can get a home loan with better terms.

Dangers of B/C loans

As evidenced by the real estate crisis that hit in 2007, borrowers unable to make their payments find themselves facing foreclosure or scrambling to modify their loans. Before you consider agreeing to a B/C loan, take a close look at your financial picture. Most B/C home loans have an adjustable interest rate. If the rate rises in the years ahead will you be able to make your mortgage payments and pay all of your other expenses? What does your income picture look like a few years from now? Would it make more sense to pay off some debts, boosting your credit rating so that you can get a better interest rate in the future?

Remember that the better your credit score the more options you have as more lenders will compete for your business.

If you are considering a B/C loan, you should also watch out for predatory lenders, who not only charge higher interest rates, but may tack on fees, hidden and otherwise, to take advantage of people desperate to buy a home. All alternative lenders are not out to gouge customers, but the loans they offer should be scrutinized carefully. If something doesn’t seem right about the loan terms or the fees seem outrageous, don’t agree to the loan just because you feel you’re out of options.

For borrowers who have gone through a foreclosure or taken a hit on their credit spending time shopping around and investigating programs is worth the effort if it spares you from ridiculously high rates and massive fees and penalties.