What is sub-prime?

Prime underwriting means full documentation, verified stable income and conservative LVR caps. Sub-prime underwriting accepts relaxed documentation, manual credit adjudication and documented exceptions to policy. Pricing is risk-based, with wider margins and higher fees to cover expected losses and capital; loans may run at higher LVRs with stricter enforcement, or unsecured with shorter terms and covenants.

Prime borrowers score well with the bureaus, keep utilisation low and have clean payment histories. Sub-prime borrowers show lower scores, past delinquencies and concentrated exposures, and their accounts need active monitoring after settlement. Near-prime sits between the two: not prime, but better than sub-prime on default probability and LVR.

Sub-prime lending rests on three pillars. First, adapted underwriting: alternative income verification such as bank statements rather than payslips, acceptance of higher LVRs or lower-quality collateral under documented exceptions, and structures such as shorter terms, balloon payments or stepped rates that shorten the lender's exposure.

Second, risk-based pricing. Expected loss is PD × LGD × EAD: the chance of default, times the likely loss if it happens, times the exposure. Fees, prepayment penalties and higher margins cover that loss plus operating costs and capital. Third, post-settlement controls: early-warning indicators, vintage analysis, roll-rate matrices and automated collections. Broker fees and securitisation can reward volume over quality, so governance has to keep origination incentives aligned with loan performance.

Sub-prime cohorts have higher and more volatile default rates, lower recoveries because the collateral is weaker, and defaults that cluster in downturns. Early delinquencies predict later defaults, borrower and originator behaviour can add losses, portfolios funded by short-term markets or securitisation are exposed to funding shocks, and models built in good times understate stressed losses. The 2007 to 2008 crisis showed how rapid origination, weak underwriting and securitisation can spread those risks through the financial system.

In Australia, APRA's APG 220 sets expectations for credit risk frameworks, origination standards, stress testing and provisioning, and a lender relaxing its standards is expected to justify it with explicit policies and extra monitoring. The responsible lending obligations in the National Consumer Credit Protection Act cover the unsuitability assessment and disclosure, with hardship rights under the National Credit Code and complaints going to the lender first and then to AFCA. Those obligations cover consumer credit, not lending wholly or predominantly for business purposes.

Sub-prime credit typically costs materially more in interest and fees, so work out the total cost over the life of the loan rather than the repayment alone. Check your debt-to-income position and realistic cash flow first, because a short-term stretch can become long-term credit damage. Secured options, family support or a negotiated payment plan may cost less than high-cost unsecured credit.

Ask for full disclosure of fees and repossession terms, compare rates and fees across offers, and stress test your budget against higher repayments. If you hit trouble, tell the lender early: hardship arrangements exist under the National Credit Code, and complaints go to the lender's internal process and then AFCA. Using them promptly limits the damage.