Subprime Lending Crisis
What is the subprime lending crisis and what caused it. Is it
really the banks and irresponsible borrowers fault or is there more
than meets the eye?
The subprime lending
crisis has everyone in an uproar. It is being blamed for the entire
down turn of the US economy. Is this really the case or are the
real facts being obscured by the media? Let us look at what caused
this crisis and how it can be turned around.
The beginning of the end: Money was easy to borrow, rates were
low, and in many areas of the US, the real estate market was booming.
"Flipping"
houses was becoming all the rage. You bought a property, made
it look pretty, and sold it for thousands of dollars in profit,
sometimes before the first mortgage payment was due. The rate of
return on your investment was huge.
Those with money and those who wanted to make a quick buck all
got into real estate although they did not really know what they
were doing. This situation created real estate prices that were
not sustainable. When any market reaches an artificial and unsustainable
high, a correction is sure to come Part one of the crises, the correction
came. Real estate prices are now falling in most of the US and sales
of homes are at their lowest in 16 ½ years.
Part two, subprime lending. Looking to make a quick profit, many
people turned to real estate although they had no formal training
or experience other than purchasing their primary residence. A good
number of people maxed out the equity in their homes to buy investment
properties. They used this money as a down payment and then borrowed
the rest. Some even took out more loans to buy additional properties.
As their credit to income ratios became less than desirable, they
fell into the subprime borrower category. Furthermore, everyone
wanted to own a home. Rates were cheap and even a marginal borrower
could get money for a home. Banks, lenders and mortgage brokers
became greedy and as the subprime market grew, so did the marketing
to bring in more borrowers.
Part three, greed. Instead of closely scrutinizing every loan,
many banks and subprime lenders saw the profit potential of making
subprime loans and selling them to investors and other institutions
that specialize in these loans. More programs became available for
no money down loans, interest only loans, 80/20 loans, and ARM loans
with very low introductory rates followed by a huge increase in
2-5 years. The subprime borrower became the ideal borrower for many
institutions. Here is where it all starts to go bad.
Part four, the crash. Real estate prices in many areas fell rapidly.
This led to an overage of houses for sale in many areas. House "flippers"
were not selling houses and they started making payments on houses
they could not afford to hold onto. They lowered their prices in
order to unload the property. The houses still did not sell, many
fell behind on payments and foreclosures started to rise.
Subprime lenders with higher than normal default rates were unable
to borrow money to make more loans and several large
lenders went bankrupt very quickly. Predatory lending compounded
the problem and many mortgages were readjusting to higher rates.
Rising gas prices, food, heating and cooling costs contributed to
making it impossible for many to afford the rate increase. Unable
to sell their homes for more than they owed on it, many went into
default.
This is how the subprime lending crisis started. It has a ripple
effect. It will take sometime for all of this to correct itself.
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