History of Subprime Lending

This is a brief summary of the history of subprime lending. As we have come to know it, subprime lending was not legal until 1980 when the Federal Government deregulated the lending industry.

The history of subprime lending, when did it start, who was responsible? These are interesting questions. The loans that are offered to many subprime borrowers today have actually been around for quite a while although they were never intended as primary loans or for borrowers with less than stellar credit.

Originally, these loans, such a balloon payments, ARM's and other non-traditional loans were geared toward the individual who needed a "bridge loan" or a loan to cover the purchase of one property while a second property was to be sold. Once that second property was sold, the bridge loan would be repaid and either a traditional loan would replace it or the property was purchased outright. For example if you bought a new house, but were still trying to sell your old one, you would get a bridge loan to tide you over until the sale went through. Then you would settle your bridge loan and go on from there.

So what happened? How is it that these loans which appear to be designed for better qualified buyers ended up being the mainstream type of loan for the subprime borrower? The answer is simple: deregulation. Back in the 1980's banking was deregulated and interest rates started to soar. Your average interest rate at one point reached well over 10%. This put the housing market well out of the reach of many buyers. Once rates stabilized things got a little better but in the fallout the subprime ARM was born.

With an ARM, you could qualify at a lower rate than you normally would. In addition, lender were offering private mortgage insurance to protect themselves in case of default. Those individuals who really wanted a home could buy one at a cost. A sector of the banking industry realized that by assuming some extra risk you could raise your interest rate, up your fees and closing costs and make a really good profit off of those individuals whose ability to repay was perhaps questionable. That is when subprime lending as we know it today entered the financial market scene.

How has it evolved into such a disaster? With banking deregulated and money becoming easy to borrow, it seems that everyone wanted to jump onto the buy real estate wagon. Real estate was looked upon as an easy way to get wealthy quickly. Courses and seminars on how to make money in real estate sprang up everywhere. Then it changed. Certain markets dropped and people lost money. New rules and regulations were put into place.

The market stabilized and prices started to rise again. Interest rates dropped, money was easy to borrow again and this was the boom in the real estate market that we just saw crash. The difference this time was the amount of money available to borrowers who normally would not have qualified for loans. Deregulation back in the 1980's contributed to this as lenders relaxed underwriting requirements and non-banking institutions were also lending money. Many loans required little to no verification of income and now we have a mess on our hands.

There you have it, the history of subprime lending in a nutshell. Although it has been around in many forms for many years, in its current form it is only a decade or so old. Perhaps we need to take a look back at the way loans used to be handled. It seemed to work for everyone for a long time.