Home loans designed for these types of higher-risk borrowers are considered subprime or nonprime mortgages.
The term subprime may 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 track records. These were also sometimes called no-doc loans because some lenders were not requiring documented proof of income.
Eventually, many of those borrowers defaulted on their loans. Between 2007 and 2010, foreclosures skyrocketed and banks lost tons of money, causing the government to bail out many big banks, while others merged or were sold through failure.
In response to the subprime mortgage crisis, the Dodd-Frank Act of 2010 was established to overhaul financial regulation in order to prevent a similar crisis in the future. Included in the act is a lender requirement called the ability-to-repay (ATR) rule. This rule requires mortgage lenders to establish a thorough process for evaluating whether a borrower is able to repay the loan according to its terms, pretty much ending the practice of no-doc mortgage loans.
Lenders also have to underwrite loans according to the standards outlined by Dodd-Frank. Violating these requirements could result in a lawsuit or other regulatory action. Additionally, subprime borrowers are required to attend homebuyer counseling provided by a representative approved by the U.S. Department of Housing and Urban Development (HUD).