The Subprime Lending Crisis In English

By now everyone who hasn't been living under a rock for the past 6 months has heard about the mortgage crisis. Basically what's going on is that during the housing boom, greedy mortgage lenders were financing huge mortgages to under qualified borrowers. Sub-prime borrowers include people with less than perfect credit and those with good credit but little or no documented proof of income. These borrowers have a higher default risk and therefore pay a higher interest rate in order to compensate for the risk they pose.

In addition to lending to sub-prime borrowers, there was a lot of adjustable rate mortgages being financed and people experience huge jumps in their monthly payments as interest rates rose so what may have originally been an manageable payment turned into something that people just could not afford to pay.

Worse yet was the creative financing. Loans that involved 0% down and interest only loans (where you pay only the interest and nothing towards the principal) made a huge contribution to the turmoil.

A lot of home buyers were expecting a huge appreciation in home values and thought that would cover them but the boom experienced for the past few years was nothing more than a bubble. Record low interest rates and the ease of getting a loan fueled this bubble. However, home values began to decline and a lot of people began to default and go into foreclosure because walking away from a loan they couldn't afford in the first place on a home declining in value was the easiest solution to the problem.

Well the greedy lenders were left holding the bag. It didn't just stop with the lenders though. Many mutual funds and securities purchased and invested in these sub-prime loans so they took huge hits as well.

The problem affects the entire market though for a variety of reasons. Whenever investors see any uncertainly and increased volatility in the market they tend to start selling off, driving down stock prices. They dump their holdings related to the issue and become more risk averse.

Unrelated stocks are affected because a lot of companies even large ones rely on debt to fund projects and operations. With the current mortgage crisis there are less funds available for borrowing and it is more expensive to borrow.

Most companies have some degree of debt. This is not necessarily bad debt because the companies finance projects and operations with the borrowed funds with the expectation that more money would be generated from the projects and operations than the debt costs them.

Anyone hoping buy a home with less than perfect credit and solid documentation can forget about it for now. However don't give up hope. Spend the next 6 months or so working on building up your credit score and fattening up your down payment. By the spring there should be some more balance and stability in both the stock and housing markets and you may be able to find some wonderful deals. Remember all these defaulted mortgages represent an available home that banks will be eager to get off their hands.

Yours Truly,
The Finance Girl