What Exactly is this Subprime Mess?

If you ever turn on the radio or television then you have surely heard something about the current “subprime mess,” “credit crunch,” or “mortgage meltdown.” What are they really talking about, and how did it happen? Read on to learn the basics.

Let’s go back in time a few years. The dot-com bubble was just about to pop. The economy was strong, and home values were rising. Then the tech bubble did pop. The stock market tanked and in an effort to squelch the problems at hand, the Federal Reserve began dropping interest rates. Interest rates fell, and fell, and fell some more. Home values at this time were still rising. Borrowing money was extremely cheap, the collateral was increasingly strong, and everybody was having a party.

For numerous reasons, the banks began to expand their guidelines surrounding to whom they would lend money. Lenders decided, “Well, ok. Even if you don’t have perfect credit, we’ll give you a chance.” They began lending money to people that didn’t have the best credit, equity in their home, or a strong ability to prove their income. In other words, lenders began lending money to people that were a little bit less than “prime” borrowers. These “less-than-prime” borrowers are also known as “subprime” borrowers.

Now we’ll fast forward to 2006/2007. Many of the subprime borrowers who bought or refinanced a house a few years ago took adjustable rate mortgages (ARMs) assuming that the low rates at the time wouldn’t adjust too terribly high. Maybe they assumed they’d be making more money when their ARM was due to reset. Or, probably most common was that people assumed the value of their home would continue to rise and they could just refi out of their ARM before it adjusts.

Unfortunately, rates today are a little bit higher than they were a few years ago, and many people are finding that theirs has adjusted to the point that their payment is unaffordable. Their income hasn’t increased as they had hoped. Perhaps their credit score has dropped due to them taking on more debt, or being a little late a couple of times on their payments.

Real estate values have not risen as many people thought they would. In fact, many markets (areas) have seen a decline in property values. When the someone bought their house, maybe they purchased it for $200,000 and borrowed 100% of the purchase price. Today the home is only worth, maybe, $185,000 and they still owe $195,000. This example could also have arisen from a refinance.

Given the above reasons, the homeowners can’t afford their payments, they can’t sell the home for what they owe, nor can they refinance because they owe more than the home is worth. What are they to do? There are really only a couple of options: convince the lender to allow them to short sell (sell the home for less than it is worth and let the bank eat the difference), or walk away from the home and allow it to go into foreclosure (there might be a couple other options, but for the sake of simplicity we won’t go into them here).

Unfortunately, foreclosure seems like the easier option for many people, and so they walk away. This process repeats itself again, and again, and again. Many people borrowed more money than they could really afford, and many of them got into complex loan programs that they didn’t understand. The result is a huge number of foreclosures hitting the market, which means high supply. Basic economics says that increasing supply without increasing demand will cause prices to drop. Consequently, property values are continuing to drop in many areas.

The mortgage markets are also feeling the pain of all of the foreclosures. The banks will try to sell the foreclosed property, and almost certainly not get enough money to cover what they have into it. Because the banks are losing money too, they are now tightening their guidelines surrounding whom they’ll lend money to. This, in turn makes it even more difficult for troubled homeowners to refinance out of their ready-to-adjust ARM.

As you can see, these problems can easily spiral out of control. Each problem creates another problem, which makes all of the problems worse, which just makes the first problem worse, which then…well…you get the idea.

Article Directory: http://www.everyonesarticles.com

--
Drew Tyler is an experienced and successful mortgage professional. To gain more insight into the mortgage industry, and make yourself a more educated borrower, please visit www.competingloans.net.

Click here for a FREE report explaining how to be debt-free and a millionaire in 30 years!

Click here for a FREE report on some de

Please Rate this Article

5 out of 54 out of 53 out of 52 out of 51 out of 5 

Not yet Rated

Click the XML Icon Above to Receive Mortgage Articles Via RSS!