Sub prime crisis,what is it all abt?

Question

Sub prime crisis,what is it all abt?

Answer 1

Lots of financial companies wrote loans with low introductory rates on adjustable mortgages.  Now the interest rates are going up, and lots of people can't afford to pay, so they are defaulting on their loans.

Their homes are going into foreclosure, and the banks aren't getting paid.  PLUS...it's hard for these people to sell, because the real estate market is soft, and it's now harder for prospective buyers to get a mortgage.

Answer 2

Subprime loans are loans (generally home mortgages) given to people who have a poor credit rating (these are people with a history of not paying their bills, or paying them late).  Because of the risk involved in loaning money to people who don't always pay their bills, these loans have a high interest rate.  That way, if some of the people don't pay, the lender is still able to make money from the high interest paid by those who do pay.  The problem with high-interest loans is that the high interest makes each monthly payment higher, so fewer people can afford them.

For a while, the prices of houses was increasing at a high rate.  Therefore some mortgage lenders decided to give people what are called adjustable-rate mortgages (ARMs).  These are mortgages that start at a low rate, but, after a set number of years, the interest rate resets to a higher rate.  That way, more people would be able to afford to buy a house, at least for the first few years.  Why did the lenders do that?  Well, lenders make money by making loans.  There are only so many people with good credit, so ARMs allowed the lender to make a profit on the initial interest and fees, and, possibly, even more when the interest rate reset.  The borrowers hoped that they could establish better credit when the interest rate was low, then refinance at a fixed rate that they could afford (that is, they were using the ARM to improve their credit score for the future).  Even if the borrower could not refinance, and could not pay the higher interest when the rate changed, the hot housing market would make it easy for them to sell the house and pay back the lender.  The lenders also knew that, with housing prices going up, if the borrower didn't make their payments, they (the lenders) could foreclose (take back) the house, sell it, and still make money.

What happened, though, is that the price of housing went so high that demand started to drop off, and housing prices stopped increasing.  Then, when all the ARMs started to reset at a higher rate, a lot of people could no longer pay their mortgages.  Some of these people tried to sell their houses, but could not, so they simply walked away from the house.  The lenders foreclosed, but, because housing prices had started to come down, they actually lost money when they sold the house.  The more people walked away from their houses, the more houses were competing for the same number of buyers.  This further pushed down the price of housing, because the lenders had to cut prices to unload the properties.  Regular people who were selling their houses for the usual reasons (relocating, retiring, etc.) had to compete with all the houses that had been foreclosed.  Therefore, these homeowners had to cut their asking prices, too.  This pushed home prices down even more.  And the more the prices came down, the more likely people would abandon their houses when their ARMs reset.

This had a few repercussions.  First of all, there are so many houses on the market, and prices are so low, that the home-building industry, one of America's largest industries, is in trouble.  While most high-paying manufacturing jobs have moved overseas, home-building is something that is difficult to outsource, because homes are generally built on site.  Therefore when the building industry is in a slump, a lot of people lose their jobs.  

The second repercussion is that many investors are losing money.  Basically, investment firms took people's investment money (from retirement funds and the like), and bought high-risk loans from the local banks.  When the loans started to go into default, the value of the investments went down, too.  This also had a negative effect on the stockmarket, since some companies also bought mortgage loans and are now losing money.

The third repercussion is for local lenders.  In the past, a local bank would take its customers' deposits and lend the money out for mortgages.  This was possible because people would put money in the bank and keep a balance (that is, they were not using the money).  The local banks therefore were limited in how many loans they could make.  But when big companies and investment firms got involved in home mortgages, the local banks would write a mortgage, make money from fees, then sell the loans to the big companies and get their money back so they could loan it out again.  Now that no one wants to buy new mortgages anymore, the local lenders have less money to loan.  This means it will be harder for people to get home mortgages, and also harder for small businesses to get loans.  The result is a reduction in economic growth.