Sub-prime Mortgages

For securing home loans, the property intended to be purchased is pledged as collateral or security. Banks while issuing home loans evaluate the repaying capacity of the borrowers first, related to their income and secondly the credit history of the barrower, whether any lapse has occurred previously in repayment of any loans, consumer loans, credit cards etc. Credit scores will generally range from 300 to 900 and a majority Americans will have the credit score from 600 to 700. Late payment of bills and debts habitually will plummet the credit score and any one falling behind in the credit score below 620 is considered to have a bad or imperfect credit history.

Lending money for buying a home for persons with sound financial background and substantial credit score is known as prime lending and the mortgage made between the lender and the borrower is called prime mortgage. On the contrary, persons with doubtful and bad credit history will also be considered for issuing home loans, irrespective of high risks for return of the capital, but based on the collateral of the proposed property to be bought. These loans are known as subprime mortgage loans.

These subprime mortgages are issued to borrowers, persons with less credit score below 620, and the risks are offset by charging high interest rates in the form of Adjustable Rate Mortgages (ARM). These ARMs will have interest rates very less in the beginning and will be adjusting over a period to high rates. The period when the rates of interest will be low is called grace period, mostly two to three years initially, when the repayment installments will be less every month.

When the Real Estate boom was in vogue in the US country during the years from 2000 to 2005, home buying activity was hectic in all the States and more so in prime locations like California, Florida, Michigan, New York, Ohio, Nevada etc. As such nobody bothered much about the sub-prime mortgages. People were frantically vying with each other in home buying when the interest rates on Home Loans, were far less when compared to other countries, due to the powerful economy in US for the last several decades.

Side by side with prime lending mortgages, subprime mortgages also flourished unabated. According to statistics, subprime mortgages were just 10% of the total originations of home loans in 2001-2003 and surged forward in 2004-2006 to 21% and by May 2008 to 25%. The subprime ARMs, which were only 6.3% of the total mortgages, accounted for 43% of the foreclosures of properties during the third quarter of 2007.

What made the triggering of foreclosures mainly from subprime mortgages is a combination of many factors such as:

• Barrowers were blissfully hoping that US Economy will never slide, the ARMs will not bulge beyond their repaying capacity, and they can very well re-finance the mortgages with soaring property prices – all these hopes were dramatically destroyed by the downturn of US economy on the one hand and property prices plummeting to the bottom on the other
• Subprime lenders were confident that defaults in repayments can be offset by the rise in prices of properties and they can foreclose to dispose off the properties to retrieve their home loans – this was not to be
• Subprime mortgages converted into securities and bought without hesitation by financial institutions, got a heavy hit by the credit crunch and a number of big subprime securities purchasing companies had to close shop or declare bankruptcy because of the foreclosure crisis

As it is millions of home owners have forfeited their properties to foreclosure crisis and home buyers have a “buyers market” to own a formidable property in a prime location at a price, which is a fraction of their fair value.

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