B, C and D paper loans are all types of alternative, or non-conforming, loans usually for borrowers with poor credit. The term “paper” simply refers to the fact that when a lender makes a loan, it takes back a promissory note and security interest such as a mortgage – which are pieces of paper. Put simple, B, C, and D loans (as well as A loans) are sub-prime loans.
Lenders like to classify loans according to risk. First they divide them into conforming and non-conforming loans. Conforming loans are the safest. Non-conforming loans are more risky and are alphabetically classified according to risk. Non-conforming A loans are less risky than B loans which are less risky that C loans which are less risky than D loans. There are no loans with lower classifications.
Non-conforming A loans, also called Alt-A loans, are usually made to borrowers who just barely miss the requirements for a conforming loan. An example would be a borrower who pays all her bills, but has paid some of them late within the last year. Since almost no one has perfect credit, this is the type of loan that most people with good credit get. There is a big market for Alt-A loans, and their interest rates are fairly competitive with conforming loans.
There are far fewer lenders who want to make Alt-B, C, and D loans (though the market is growing), so there is less competition for these borrowers causing
interest rates to be higher. That these borrowers are seen by lenders as more risky and more desperate also pushes up the interest rates with these non-conforming loans.
Sometimes alternative loans can be predatory, but they can also have their place for homebuyers with less than perfect credit. For instance, if a homebuyer has poor credit because he has some recently paid debts that will come off his credit report in the next few years, he can get an Alt-B or C loan and make timely payments on it. This will improve his credit and allow him to refinance for a conforming loan faster than if he just pays off the old debts and waits until he is able to qualify for a conforming loan. Borrowers in this situation should be careful that there are no significant pre-payment penalties, which are common with non-conforming loans, preventing them from refinancing.