What is a Sub-prime Mortgage Crisis?

Published by Thomas Herold in Banking, Economics, Laws & Regulations, Real Estate

'Sub-prime Mortgage Crisis' is explained in detail and with examples in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

The sub-prime mortgage crisis proves to be a still going financial and real estate crisis. It continues to revolve around the steep decline that you saw in American housing prices, the resulting increase in numbers of mortgage delinquencies and finally foreclosures, and the ultimate fall of securities that are backed up by these sub-prime mortgages.

The problems began with the fact that around eighty percent of all United States mortgages that banks gave out to sub-prime borrowers, or people with less than perfect credit, turned out to be adjustable rate types of mortgages. Housing prices actually reached their highest point in the middle of 2006 and then began sharply falling. This caused refinancing of interest rates on mortgages to be harder to obtain. The double edged sword of adjustable rate mortgages resetting at their higher rates started, causing an enormous number of delinquencies and finally foreclosures in mortgages.

The greater problem came as these mortgages underlay a number of financial securities that many financial firms held in huge numbers. They saw most of their value disappear in the following months. Investors around the world then began to dramatically cut back on the quantities of collateralized debt obligations and other mortgage securities that they bought. Besides the damage that increasing sub-prime mortgage delinquencies and foreclosures created themselves and for the investments based on them, this sub-prime mortgage crisis led to a fall in the ability of the banking system to engage in lending. This caused significantly tighter credit and lower rates of growth throughout the developed world, in particular in Europe and the United States,that are still plaguing the industrial countries.

Ultimately, the sub-prime mortgage crisis arose as a result of easy up front loan terms which banks made to borrowers. Both the borrowers and the banks felt confident that the loans could be easily refinanced into better terms as needed, since housing prices were steadily rising over a long term trend. Financial incentives were provided to sub-prime mortgage originators.

This coupled, with fraud that borrowers and lenders engaged in, significantly boosted the quantities of sub-prime mortgages to customers who should have received standard conforming loans or who should not have received loans at all. When the easy interest rate terms expired, the majority of sub-prime loan holding consumers could not refinance at the better rates in which they had believed. The interest rates reset higher, dramatically increasing the monthly mortgage payments.

Home prices started falling to the point that homes were no longer even worth as much as the original mortgage, meaning that they could not be sold to pay off the mortgage obligation. Instead, the borrowers’ best interest lay in going through foreclosure and walking away from the hopelessly underwater homes. This continuous epidemic of foreclosures that began with the sub-prime mortgage crisis is still a major continuous part of the world wide financial and economic crisis. The foreclosures are still taking away wealth from consumers and sapping away at the damaged banks’ balance sheets.

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The term 'Sub-prime Mortgage Crisis' is included in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.