September 25, 2023


Mad about real estate

Subprime Mortgage Lending

“Subprime Mortgage Lending and Its Effect on The Economy”

            In the 1990’s the United States saw a rapid growth of subprime mortgage lending. Lending institutions started to give credit for mortgages to millions of borrowers who may have been denied credit in the past. Homeowners who were not as fortunate as others were now able to borrow credit to meet their needs. As this created a good opportunity for some people it has also “been associated with higher levels of delinquency, foreclosure, and, in some cases, abusive lending practices.”(1) It now seemed that anybody could get a mortgage due to these subprime loans. What people did not realize was that during the 90’s the economy was good and interest rates were low. Later on rising interest rates caused many problems and forced many lenders and borrowers into trouble. Subprime mortgage lending did not turn out as great as everyone thought it would be and it ended up negatively effecting the economy.

To explain the effect subprime mortgage lending has on the economy you must first understand what subprime lending is. Subprime lending is when a person who does not qualify for loans from mainstream lenders borrows money from a subprime lender. These people are called subprime borrowers. They are unable to qualify for prime financing terms but can qualify for subprime financing terms. The main reason these people are unable to qualify is because of low credit scores. Lenders judge borrowers credit history based on a “Fair Isaac and Company (FICO) credit score.”(2) An average credit score below 620 is viewed as a high risk and makes that borrower unable to receive a prime loan. However, research shows “about half of subprime mortgage borrowers have FICO scores above this threshold.”(3) When a borrower takes a subprime loan they have to pay a high interest rate depending on their credit score. The lower the credit score the higher the rates will be. Because of the greater risk and higher costs of subprime lending, subprime loans have a greater interest rate. Subprime lending seemed to be a great way of giving everyone a chance to be able to get a mortgage but in the long run it ended up causing many problems and hurting the economy.

As subprime mortgage lending started to become very popular, many problems started to occur. “By 2005 26{ef6a2958fe8e96bc49a2b3c1c7204a1bbdb5dac70ce68e07dc54113a68252ca4} of mortgage loans were subprime.”(4) It seemed to be an incredible opportunity but later on “interest rates rose and customers were unable to continue making their loan payments.”(5) This caused many problems and there was a great amount of mortgage defaults and foreclosures. Many lenders had no choice but to give up their businesses. On top of that their bond funds became worthless. These losses caused many lawsuits with companies and individuals who were hoping to have some sort of recovery. The Federal Reserve started to get involved to help lenders who were in deficit. In an article from “Americans For Fairness In Lending” the Federal Reserve was said to “lower its rate to lenders and adjust its collateral standards in a quick effort to soften the blow of the collapse on Wall Street.”(6) The Federal Reserve was forced to help out subprime lenders because they were the first to be affected by the large amount of foreclosures. Lenders and borrowers were not the only ones to experience losses. Major banks and financial institutions all around the world were said to have “reported losses of approximately 240 billion U.S. dollars.”(7) Also corporate, individual, and institutional investors suffered when the value of mortgage assets declined. Stock markets have declined in countries all over the world as well.

Subprime mortgage lending has now become a “subprime crisis.” It started to have a negative effect on economic growth and effected investments, which are a crucial part of supporting the economy. Housing prices have sky rocketed in many areas and there has been a lower percentage of home construction. This puts a negative effect on the housing market because there is not enough money to build new homes to sell. Because of rising interest rates expected to continue United States legislatures and the U.S. Treasury Department are developing a plan to help the economy. As interest rates continue to rise more of the economy is going to be negatively effected.

Subprime mortgage lending has not only effected the large economy but has effected borrowers, neighborhoods, and local economies as well. The Federal Reserve has been helping lenders and the larger economy but they have not given any money or passed any legislation to help out these suffering consumers, neighborhoods, and local economies. Homeownership due to subprime lending has caused unstabalized communities and a loss of family wealth. A statistic from the Center for Responsible Lending shows that “Subprime loans made during 1998-2006 have led or will lead to a net loss of homeownership for almost one million families.”(8) If losing their homes wasn’t bad enough these families will lose the money they have invested in them as well. With each foreclosure property value can go down too. “It is estimated that each foreclosure lowers the property values in its neighborhood by about one percent.”(9) All of this will hurt neighborhoods and will take money away from what these borrowers can spend on goods and services. When these borrowers have less money, then they will have less money to spend in their respective communities. Neighborhoods will become poorer and crime and violence can occur. Subprime mortgage lending has seriously taken a turn for the worst with the booming interest rates and has seriously hurt subprime borrowers.

Many corporations and financial services have been greatly effected in the past few months from subprime mortgage lending as well. According to an article by CNN, New Century Financials “shares plunged nearly 70 percent.”(10) In the same article Fremont General Corporation was said to “lose a third of its value after it announced it would exit the subprime sector because of the demands of regulations and market conditions.”(11) Due to loss of money and an increasingly large number of foreclosures the “Center for Responsible Lending” asked for tougher standards for lenders who make subprime loans. This seemed to get into other firms minds as the mortgage financing firm “Freddie Mac” said “it would no longer buy subprime loans on the secondary market that have a likelihood of excessive payment shock and possible foreclosure.”(12) These new guidelines along with a new set of proposed federal rules are going to leave many borrowers unable to qualify. With less people able to qualify the less the subprime loans there will be. This will hopefully stop the rising amount of foreclosures, which hurt the economy so greatly.

Subprime mortgage lending has seriously effected the economy in a negative way. The stock market has declined and interest rates are still rising. The Federal Reserve has made changes to help cut interest rates and the proposal of “the economic stimulus package signed by President George W. Bush”(13) has been made to help encourage economic growth and give financial markets some confidence. These things will help but it is going to take a while for the economy to bounce back. Subprime mortgage lending was thought to be a great opportunity at first, but in the end it hurt the economy greatly.