Do those considered "sub-prime" morgatage lendees know that they are "sub-prime"?

Yes, people know if they have a good loan officer. Full disclosure is a part of their job.

Although the ability of sub-prime borrowers to get loans has been virtually eliminated for the duration.

And for a while, sub-prime loans were easier to get than prime loans, with competitive rates. So some prime borrowers could qualify for subprime loans more easily.

Generally, as part of the loan application process the institution runs your credit report, and this is made available to you. Also generally, the rate you pay depends on your credit rating while the amount you can borrow depends on the term of the loan and the monthly payment you’ll need to make, which is itself a function of your available income (your net income minus any obligations you have like an existing mortgage, student loans, car payments, etc.).

So you can read your “prime” status in your credit rating and the interest rate the bank offers you.

I don’t think it is that clear cut. Maybe it is the blinders involved in being the applicant for a loan, but I don’t think most folks consciously think of themselves as sub-prime or high-risk. What you hear is “we’ve got a way to get you the money you want”. Especially when the issue is a house (as opposed to other loans or unsecured debts) everyone says that buying a house is a good idea. You almost never hear someone say “buying is better than renting, unless you are high-risk”. Owning your home is culturally and economically highly desirable. At least this was my experience as the recipient of one kind of sub-prime loan.

@mangus: no, the lenders don’t come out and say “We think you’re high-risk,” or “We think you’re sub-prime,” but the indicators are all there. You can find websites out there that draw the lines between prime and subprime in terms of FICO scores; while the actual numbers may vary from lender to lender, whether a buyer is prime or subprime really is that clear-cut. And as you note a lot of this feeds on itself: the people who have poor credit ratings tend to be aware of it, and are so happy that they got approved for a loan at a payment they can afford that they don’t look too closely at the credit report or at the percentage rate.

What’s fuelling the current mortgage problems, though, is twofold. Banks expect a certain amount of defaulting; this is why there’s mortgage insurance involved until the homeowner has a certain amount of equity in the house. If the homeowner defaults after that equity is there, the bank can claim the house and not lose money; if the homeowner defaults before that equity is there, the insurance pays the bank. But people are defaulting at higher rates than they should, and it turns out that this was because banks approved a lot of loans to people they should not have, and this was foreseeable at the time.

The other problem is that a lot of people who would have been reasonable credit risks at the payments their adjustable rate mortgages started at found that they could not make their payments when the rate adjusted upwards. ARMs are a great idea if you have a bit of foresight and the resources to refinance ahead of it becoming necessary; they’re a nightmare if you don’t realize what you’re getting into.