Evils of Subprime Lending

You read everyday about the evils of subprime lending. What started this mess in the first place? Is subprime lending really a bad thing or is it something that was misused by many?

You read about it in daily in the newspaper. You see it on the news links on your browsers homepage. The evening news cannot seem to let go of the subject. They are all spewing the evils of subprime lending.

There are many downsides to subprime lending. The name in itself accurately describes the type of borrower that subprime loans are designed for. Those individuals are at a higher risk for default on the loans due to their current credit situation. Lenders who deal in the subprime market usually charge higher fees and interest rates to the subprime borrower to compensate for the higher risk involved. So how did we get into such a mess?

The reason is clear: greed. Greed by the borrowers who allowed themselves to get into situations they could not afford to be in and greed by mortgage brokers and subprime lenders who made loans to individuals that had no business borrowing money. Combine that with low interest rates and money that is easy to get, and you have the beginning for a disaster.

Do you remember when you could borrow up to 125% of your home's equity? Even 2 years ago, that was possible. Many people saw that and combined with a low interest rate they started to refinance or take out home equity loans and lines of credit. They maxed out that 125% in real estate markets that were seeing unprecedented growth, thinking they could always refinance or sell if they needed to. Unfortunately in many areas that meant unsustainable growth and an eventual crash of the real estate market.

Now these individuals are in a situation that they cannot sell their homes because what they can sell the house for will not pay for the loans they are carrying.They cannot refinance because they have negative equity (the loan exceeds the homes value) and they do not have cash to make up the difference. Compound that with a mortgage that goes up every couple of years as the rate resets on their ARM (adjustable rate mortgage) and now you have a large amount of people in a lot of trouble. This situation frequently leads to foreclosure on a home. Foreclosures will drive the housing market down further as the homes are auctioned off and rarely are full market value paid.

To further describe the evils of subprime lending lets look at a few other types of subprime loans available to a subprime borrower with little or no cash for a down payment. There are several to discuss here. The first is the 80/20 loan. This is driven by sheer greed, as no responsible person should consider a loan like this. You borrow 80% of the purchase price with a conventional ARM or fixed rate loan.

Then because you have no money down, you borrow 20% of the purchase price as a home equity loan. The home equity loan is at a higher rate and some of these loans can be readjusted at the lenders whim. Another loan that was pushed by greed is the negative amortization loans or interest only loans. Both of these loans are great for lenders, as the loan actually gets larger as time goes on.

The borrower loses because if they just keep making the monthly payments, the loan will never get paid off until the balloon payment at the end of the loans term. These are just a few examples of the evils of subprime lending. Loan programs that only benefit the lender have put a lot of people in real trouble.