This is called a credit rating ; although covered by privacy lawsthe information is readily available to people with a need to know in some countries, loan applications specifically allow the lender to access such records. Subprime borrowers have credit ratings that might include: Lenders' standards for determining risk categories may also consider the size of the proposed loan, and also take into account the way the loan and the repayment plan is structured, if it is a conventional repayment loana mortgage loanan endowment mortgagean interest-only loana standard repayment loan, an amortized loana credit card limit or some other arrangement. The originator is also taken into consideration.
This entailed making the financing of home purchases as easy as possible. Various financial institutions were set up over time to make the securing of a mortgage quick and convenient. There once were Savings and Loan Associations that were savings institutions which could only invest in home mortgages.
This meant that if a bank granted a mortgage to someone and later the bank needed funds the bank could readily sell the mortgage to Fannie Mae. However, in order for lending institutions to have access to the secondary mortgage market of Fannie Mae they had to abide by Fannie Mae's rules.
In the past Fannie Mae prohibited the lenders it was dealing with to engage in the practice of red lining. Red Lining meant that a bank would refuse to finance a home purchase in neighborhoods it consider high risk even if the prospective borrowers were themselves good credit risks.
In part, this was because the bank did not want, in the event of default and foreclosure, to become the owner of property in a risky neighborhood. The deeper roots of the problem go back to the Community Reinvestment Act of In the 's under the administration of Franklin Raines, a Clinton Administration appointee, Fannie Mae began to demand that the lending institutions that it dealt with prove that they were not redlining.
This meant that the lending institutions would have to fulfill a quota of minority mortgage lending. This in turn meant that the lending agencies would have to lower their standards in terms of such things as down payments and the required incomes.
These subprime borrowers would be charged a higher interest rate. Having put the lending agencies into the position of granting subprime mortgages Fannie Mae then had to accept lower standards in the mortgages it purchased.
That set the ball rolling. If a bank granted a mortgage to a borrower that was not likely to successfully pay off the mortgage then all the bank had to do was to sell such mortgages to Fannie Mae.
The banks typically earned a loan origination fee when the mortgage was granted. The lending agencies could then make substantial profits dealing in subprime mortgages.
Because Fannie Mae and Freddie Mac made a market for subprime mortgages the lenders did not have to worry about of the soundness of the mortgage contract they wrote. Thus the lenders could write the mortgages as adjustable interest rate mortgages knowing full well that an upturn in the interest rates could easily throw the borrower into insolvency.
For many of the subprime borrowers living on the edge of insolvency this would be enough to push them over the edge. The guilt for the subprime mortgage financial crisis lies both with the lenders who knowingly put borrowers into booby trapped mortgages and the management of Fannie Mae and Freddie Mac for making a market for such booby trapped mortgages thus giving the lenders the incentive for writing them.
The subprime borrowers were charged a higher interest rate to compensate for the higher risks. Obviously the borrower that could not qualify for the mortgage at the lower rate was going to be more of a risk at the higher rate.
It seems that everyone but the dimwits running Fannie Mae into the ground understood intuitively that a poor risk for a mortgage cannot be made a better risk by charging a higher interest rate.
Here are some illustrations of the point. The graph below shows the relationship between expected rate of return and risk, called the market line, that separates the good investments from the bad investments.
The dot shows a subprime mortgage. The dot being below the market line indicates that it given its risk and return it is not a good investment. No rational investor would invest in it. The next graph shows the attempt to make it a good investment by increasing the interest rate; i. But the increase in the interest rate increases the risk of default, so the movement is from point 0 to point 2.
Given the increase risk the dot is even farther below the market line and is an even worse investment than at point 0. There is the experience of the junk bond market that collapsed once investors realized that the higher rate of interest on the junk bonds was not sufficient to compensate for their higher risk.
The presumption was that although there would be a higher default rate at the higher interest rates there would be some lenders large enough to pool these mortgages and even with their higher default rates make a higher rate of return. In the case of the junk bonds the higher interest rates were not enough higher to compensate for their higher risk and the junk bond market collapsed.
A similar sort of thing occurred with the subprime mortgages. Fannie Mae and Freddie Mac pooled the subprime mortgages and then created securities which were sold around the world. When the subprime borrowers defaulted on their mortgage payments that led to the real estate market being flooded with houses for sale.
The subsequent decline in housing prices then led even prime borrowers to walk away from mortgages where the mortgage debt exceeded the market value of the property.
Fannie Mae and Freddie Mac were inundated by default claims from the mortgage default insurance they had provided. When Fannie Mae and Freddie Mac were declared bankrupt by their managers there was an instantaneous loss in value for not only the subprime mortgages but also the prime mortgages.
Fannie Mae and Freddie Mac had provided default insurance on approximately one half of all American home mortgages. Thus the bankruptcy of Fannie Mae and Freddie Mac could have led to the bankruptcy of any major holder of mortgages or securities based upon mortgages. In Fannie Mae was turned into a private company in large part because Congress wanted to separate Fannie Mae from its own budget accounting.The subprime mortgage crisis, which guided us into the Great Recession, has many parties that can share blame for it.
For one, lenders were selling these as mortgage-backed securities. When these subprime borrowers began to default, so the narrative goes, the dominoes began to fall, eventually helping to send the entire mortgage market, U.S.
financial system, and global economy into crisis. Fulfillment by Amazon (FBA) is a service we offer sellers that lets them store their products in Amazon's fulfillment centers, and we directly pack, ship, and provide customer service for these products.
As a guest on Jay Leno's new show recently, Rush Limbaugh stated that the subprime mortgage crisis can be blamed on: Barney Frank, Chris Dodd, Bill Clinton and. The United States subprime mortgage crisis was a nationwide financial crisis, occurring between and , that contributed to the U.S.
recession of December – June   It was triggered by a large decline in home prices after the collapse of a housing bubble, leading to mortgage delinquencies and foreclosures and the .
By Calum Ross. Are you real estate rich and liquid capital poor? It’s a situation far too many home owners and real estate find themselves in these days.