You read about it every day, literally. You hear about subprime mortgages, a credit crisis, and tightening of the credit and financial industry. What do these things actually mean? Do you really know, or have your eyes glazed over after reading headline after headline (after headline…) about subprime mortgages? Let’s take a look.
What is subprime lending? The practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history.
Is subprime lending risky? Subprime lending is risky for both lenders and borrowers due to the combination of high interest rates, poor credit history, and adverse financial situations usually associated with subprime applicants. Due to the increased risk, subprime loans are offered at higher rates than loans given to applicants with excellent credit history.
What is a subprime mortgage? The term “subprime” refers to the credit status of the borrower (being less than ideal), not the interest rate on the loan itself. Simply put, a subprime mortgage is a loan that is given to a borrower who has less than an ideal credit history.
Now that the basics of what subprime means at its core, lets look at the financial markets in more broad terms to shed light on what the “credit crunch” is all about.
What is a credit crunch/crisis? A credit crunch is a recessionary period in a debt-based monetary system where growth in debt money (or “credit”) has slowed and subsequently causes a drying up of liquidity in an economy. Simply put, given the risky behavior that lenders have engaged in, obtaining a mortgage is now more difficult than in the recent past.
What causes a credit crunch/crisis exactly? The current credit crisis began early in 2007 with rising delinquencies (and thus, foreclosures) in the subprime mortgage sector. This was an issue for various reasons, but related to the credit crisis, financial services companies had securitized these (mainly subprime) mortgages. Securitization is a fancy way of saying companies bought up a bunch of loans, packaged them together as an asset, and then sold them to investors. Thus, there was significant exposure to these investment pools (i.e. the subprime mortgages that began to see more and more foreclosures), and financial institutions and investors started to realize that they were in over their heads.
Perhaps a better grasp of these fundamentals will assist in understanding where we have been, and where we are heading. It can be said that because of the position that we are now in (regardless of who’s fault it is), future growth, at least in the short-term, will be organic. Organic and well thought through growth that is grounded in fundamentals is always a positive thing, as it gives a base of integrity to build on.
(Thank you to Wikipedia for assistance with some definitions)
Keith Munsell 
Great article. As a nation, we’ve learned our lesson when it comes to saturating the loan marketplace. Put simply…it became very simple to secure a mortgage regardless of your financial/credit position. In theory, there is room for subprime mortgages in the world but restrictions must be levied to make sure only the most capable sub prime borrowers qualify. A struggling economy often hurts subprime borrowers the hardest as the income needed to pay the high interest mortgage bill disappears. As an industry, the mortage business is now enforcing strict guidelines for a loan causing the money lending market and housing market to slow.
Good stuff, very basic and easy to understand. I’m sure I’m not the only one who is tired of hearing about the subprime loan crisis. I only wish that some of the “victimized” subprimers would have stopped to understand what they were doing before they got in way over their heads. Nothing irritates me more than hearing lawyers on the radio offering their services to subprimers who were “forced” to accept subprime mortgages and are now defaulting on them. And we are all paying the price for their bonehead moves. On the other hand, some blame also needs to be assigned to the “Kirby salesmen” who intentionally provided aggressive loans to folks that were obviously biting off way more than they could chew. Bottom line, not everyone can afford the American dream. As a nation, we need to start coming to grips with that.
Informative and easy to read. As Montell said, clearly the lenders are partially at fault for creating the crisis, and could use a lesson in how to “be fair”. However, I believe most of the blame falls on the borrowers. I too am frustrated by the scores of people who eagerly tipped up their cups and drank in the lower initial subprime payments without stopping to consider the possible consequences. Though, it is likely that for many potential borrowers struggling to figure out the family finances for their first home, the choice was probably not as easy as choosing between a black or white hockey helmet. It is unfortunate that the burden from government-backed loans will fall on all taxpayers, many of whom opted for the conservative higher traditional fixed financing. Doop!
I twitch as I read your comments Montell. Prior postings failed to mention that as we approached the millenium, we saw a celebration of unprecedented financial gains. No authority could make it stop and brokers hid their wallets as they walked thru the biggest double cross scam we’ve ever seen. At that time, I had a friend who would his sales manager often referred to as an industry “rookie”. “Magic” was his response whenever I asked how he doubleD his income in a year. Ask yourself why? Over and over I’ve done this, yet have no explanation why complete strangers have said “be my lender” to the snakes on the phone in California working for another loan giant. In closing, I’d advise that before you sign at the “X” you trust the person you’re working with. After all, they are the ones who can see a creaser in an otherwise ironed out deal. Don’t blame the consumer.