How to Understand Subprime Lending Problem
Examine what a sub-prime loan is., Understand that the whole problem started when people without the means to pay back money were loaned money, undoing previously cautious lending decisions. , Note that there are many remedial actions which can...
Step-by-Step Guide
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Step 1: Examine what a sub-prime loan is.
Although the prefix sub usually means below, in this case, it means higher than, or more than prime, or the prime interest rate.
The prime interest rate is the interest rate banks are charged for loans, and doesn't reflect the typical rate on a personal mortgage, although when the prime rate falls, especially for several quarters, and a significant amount, other interest rates usually follow suite.
This means borrowers were paying higher than prime interests rates, which results in higher monthly payments. -
Step 2: Understand that the whole problem started when people without the means to pay back money were loaned money
, The world economy is pretty much stable and sustainable compare to earlier recessions.
Although market parameters are more complex than before, there are no quick fixes for the current prevailing economic slump.
However, simple rules of macro economics and micro economics can resolve the challenges. ,, This is the heart of the current sub-prime mortgage troubles, and here is a simplified view of credit companies rationale for issuing sub-prime loans to under qualified buyers.
Real estate values increased faster than almost any other market or investment program over the past 20 years.
Average earnings increased at a fairly steady rate (averaged) over the past 40 years.
Inflation and low interest returns on other investments were not satisfying many investor's desires for larger returns.
A perception that if sub-prime mortgages failed at a predicted rate, the reselling of these properties would generate profits, not losses, for the investors involved.
There possibly has been an underlying thinking in some investor's minds that the government would step in to bail out the buyers if they faced foreclosure, and to a limited extent, this has occurred. , People on both the buying side of this economic dynamic and the selling side were overconfident in both the continued climb of real estate values and sales, and assumed that earnings would increase without a similar increase in the cost of living, which would enable the buyer to handle the high cost of the loan. , Gasoline and other fuel prices have steadily increased for the past 4 years, as have medical, insurance, education, and food prices.
This could be considered a contributing factor in a buyer having less money from their monthly income to use for making their mortgage payments. , Even in areas where real estate values are relatively steady, a situation that is unusual in the present (2007-2008) market, most markets have experienced a dramatic down-turn in sales, so buyers who purchased property to take advantage of the strong market a few years ago to net a profit on their purchase are looking at the loan costs out-pacing their investment appreciation, offering them little incentive to maintain the integrity of their loans. , -
Step 3: undoing previously cautious lending decisions.
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Step 4: Note that there are many remedial actions which can eliminate the negative effects of sub-prime lending.
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Step 5: Be aware that a downtrend of the financial markets doesn’t mean effectively that overall world economy is under threat.
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Step 6: Look at the history of real estate value increases and decreases.
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Step 7: Consider the above factors
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Step 8: although they are not to be taken as facts in all cases
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Step 9: nor do they all apply to every case.
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Step 10: Look at other events that have contributed to the buyer having less funds available to make their mortgage payments each month.
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Step 11: Look at the down-turn in the real estate market.
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Step 12: Realize that the markets are no more or less volatile than they have been in the past
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Step 13: and that an upswing in the real estate markets could turn the situation around in a fairly short period.
Detailed Guide
Although the prefix sub usually means below, in this case, it means higher than, or more than prime, or the prime interest rate.
The prime interest rate is the interest rate banks are charged for loans, and doesn't reflect the typical rate on a personal mortgage, although when the prime rate falls, especially for several quarters, and a significant amount, other interest rates usually follow suite.
This means borrowers were paying higher than prime interests rates, which results in higher monthly payments.
, The world economy is pretty much stable and sustainable compare to earlier recessions.
Although market parameters are more complex than before, there are no quick fixes for the current prevailing economic slump.
However, simple rules of macro economics and micro economics can resolve the challenges. ,, This is the heart of the current sub-prime mortgage troubles, and here is a simplified view of credit companies rationale for issuing sub-prime loans to under qualified buyers.
Real estate values increased faster than almost any other market or investment program over the past 20 years.
Average earnings increased at a fairly steady rate (averaged) over the past 40 years.
Inflation and low interest returns on other investments were not satisfying many investor's desires for larger returns.
A perception that if sub-prime mortgages failed at a predicted rate, the reselling of these properties would generate profits, not losses, for the investors involved.
There possibly has been an underlying thinking in some investor's minds that the government would step in to bail out the buyers if they faced foreclosure, and to a limited extent, this has occurred. , People on both the buying side of this economic dynamic and the selling side were overconfident in both the continued climb of real estate values and sales, and assumed that earnings would increase without a similar increase in the cost of living, which would enable the buyer to handle the high cost of the loan. , Gasoline and other fuel prices have steadily increased for the past 4 years, as have medical, insurance, education, and food prices.
This could be considered a contributing factor in a buyer having less money from their monthly income to use for making their mortgage payments. , Even in areas where real estate values are relatively steady, a situation that is unusual in the present (2007-2008) market, most markets have experienced a dramatic down-turn in sales, so buyers who purchased property to take advantage of the strong market a few years ago to net a profit on their purchase are looking at the loan costs out-pacing their investment appreciation, offering them little incentive to maintain the integrity of their loans. ,
About the Author
Jean Cooper
Enthusiastic about teaching practical skills techniques through clear, step-by-step guides.
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