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What Caused the Subprime Mortgage Crisis?

Declining home values contributed to the subprime mortgage crisis.
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  • Written By: Tricia Ellis-Christensen
  • Edited By: O. Wallace
  • Last Modified Date: 17 November 2014
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The subprime mortgage crisis is an ongoing event likely to affect buyers who purchased homes in the early 2000s for a long time. These effects will translate to changes in the housing market, consumer spending, changes in lending practices, and perhaps, revamping of the home loan system. What is meant by the subprime mortgage crisis is that many home loans taken out during a housing bubble occurring on the two US Coasts, from 2000-2005, were given at a subprime rate, and have now led to extensive foreclosures on home loans, and people having to leave their homes because they can’t afford the payments.

The housing bubble, meant that for a time, houses sharply increased in value and consumers often borrowed at a subprime (less than the lowest) rate believing that the price of their homes would rise and they could thus refinance for lower payments. Many people didn’t just refinance for lower payments but also for consumer spending. Inflation of house prices meant people in possession of a home suddenly had more equity in their home. They could access some of that equity by refinancing, and spend the money as they chose.

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Unfortunately, the bubble began to burst in late 2005 and houses began to decline in price. People who refinanced, especially those who did so with variable interest rates, suddenly had homes valued at much less. Many with variable rates and interest only loans ended up unable to continue making payments on their home, flooding the market with more homes for sale than usual and further lowering home values.

Another issue at hand was that a variety of mortgage companies that had issued subprime loans, invested their money in hedge funds that became worthless. This meant that several of the largest lenders of subprime loans contributed to the subprime mortgage crisis by having to claim bankruptcy and foreclose on loans. People who now had homes at lower values, had loans larger than the value of their homes, and were frequently unable to refinance with other lenders. Stricter lending practices by remaining mortgage companies has also been a factor in the subprime mortgage crisis, since some of the homeowners were ineligible for any type of loans based on new criteria.

A country’s economy is usually affected by a wide variety of factors. Reductions in spending, losses in the stock market, bad investments, and many other things can affect home price. The instability of the stock market, hedge funds that failed, and reduced consumer spending have all caused an increasing devaluation of homes and been partly to blame for the subprime mortgage crisis. It is unclear exactly when this issue will be resolved since so many factors have contributed. For now, it is clear that many have lost their homes and their ability to purchase new homes, and this has affected the rental market. Rental prices have gone up because demand for rental residences has increased in this crisis’ wake.

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sneakers41
Post 5

SurfNturf- I agree with you. I was buying a short sale from a homeowner that bought a brand new home and a year later bought a condo on the beach with two adjustable rate mortgages.

The beach property which I was interested in purchasing had 100% financing on this property with two separate lenders. He had taken out a subprime loan to purchase this property only a year after buying a brand new home in another state.

The value of the property plummeted from $450,000 to just $200,000, and he was not able to sell at the $200,000 price because there were so many foreclosures by that point, that it pulled the market price lower.

Also, the complication of settling with two separate banks was difficult because in this case the first mortgage gets paid off with the proceeds of the sale but there are no funds available for the second mortgage.

This lender wanted an additional $70,000 which is why the property eventually went into foreclosure. The important thing to remember is only buy what you can afford, and be very careful with second mortgages. They should not be used as a down payment on a home as it was in this case.

This is a classic example of how the US subprime mortgage crisis revealed itself.

surfNturf
Post 4

Subway11- Understanding the subprime mortgage crisis is not difficult. The real estate prices were soaring and credit was easy. Everyone wanted to profit from the real estate market.

People that had never considered investing in real estate owned several properties financed my adjustable rate mortgages that reset at much higher interest rates.

Many of these investors were looking to quickly sell the home almost as quickly as they bought the property. Many homes were bought and sold in this fashion until the real estate bubble happened and housing prices plummeted.

These investors were now finding that they could not keep pace with their multiple mortgage payments and homes began to go into foreclosure in record numbers.

The banks were not off the hook either. They often provided no doc or no documentation loans to borrowers and took their word that they made the salary they made in order to qualify for a mortgage.

Many of these mortgages were with adjustable mortgage rates with no money down. The banks quickly profited a handsome sum until the housing crisis began.

Subprime loans were offered to borrowers that traditionally would not qualify for a standard loan. Banks began investing in subprime mortgages and when these mortgages defaulted was the beginning of the subprime mortgage loan crisis.

subway11
Post 3

Spasiba- I totally agree with you. Many people qualified for loans that they could not afford. If you don’t have the traditional 20% down payment for the home then you probably can not afford it which is why you automatically have to pay private mortgage insurance on loans above an 80% loan to value.

There are many mortgage products out there that are not designed for all borrowers. For example, the adjustable interest only mortgage option that got so many borrowers into trouble was not designed for the average homeowner.

This type of mortgage loan is best for a seasoned investor. The reason is simple. The season investor knows the market and is probably planning on renting out the property for a few years and then selling it for a profit.

The investor is not looking to keep the property long term. If the investor can not sell the home, he just continues to rent it out until he can, which is why this type of loan brings the best cash flow for the seasoned investor.

These loans offer the lowest monthly payments which allow the investor to profit in the short term from rental income.

The average homeowner wants to do the opposite and expects to stay in the home for a long period of time. A regular homeowner needs a fixed rate mortgage that is about 25% of total household expenses.

Anything too much higher might make paying the regular bills a problem.

spasiba
Post 2

There are certain laws in life that have to be followed otherwise, sooner or later the price must be paid. One of those laws would be, if you acquire something that you can not afford, most likely you will not be able to keep it.

We tend to blame somebody else, but we are also part of the problem. One should not buy a home with no down payment. Or one should not buy a home with a variable interest rate if monthly payment is already high when interest rates are low. What will happen when interest rates go up? And as we know, they will. Most definitely one should not buy a home and pay interest only.

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