Tuesday, May 08, 2007

Understanding the Sub Prime Mortgage Crisis

Many people have heard of the subprime mortgage crisis but have no idea exactly what that entails or how it impacts the middle and lower classes. In summary subprime mortgages are made to those with weak credit who might not otherwise qualify for the mortgage they are seeking. The reason for the crisis and the unfolding explosion of foreclosures is that these loans were often given without verification of income or assets and usually at higher interest rates.

With the explosion of home prices in many areas of the country, many families wanted to experience the American dream of home ownership. As the prices skyrocketed but wages remained flat, more and more people simply did not qualify for traditional mortgage loans. They instead turned to these so called subprime mortgage programs. Many families were allowed to secure mortgages with 100% financing and without income verification. A family making $50,000.00 per year could now get 100% financing on a $400,000 loan. Most families felt they could swing the payments and if not they would sell at a huge profit since home values were rising so quickly. Then the bottom fell out. As more and more of these type of loans went into foreclosure, the housing market slowed and values dropped. This left many families with homes worth less than the loan.

How exactly did this all happen? Some of it was fraud on the part of the lender and some on naivete on the part of the borrower. Mortgage originators are normally paid based on the size of the loan but can increase their commissions with either more origination fees (points) or higher interest rates. Many borrowers were simply not savvy enough to understand the specifics of what they were signing. The fallout from the subprime mortgage collapse will be felt throughout the economy as more and more homes go into foreclosure and buyers become skittish to purchase homes during the current downturn.

Read the NY Times article from today on this subject.

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