What is Subprime mortgage spillover or mess? Please explain.?

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An answer in very lucid and layman language would be fine

2 Comments
  1. Reply
    Alletery
    February 7, 2014 at 1:22 pm

    In one very brief sentence, mortgages are given to people who cannot afford it. For an in-depth understanding, I would suggest that you read the two links below:

    An explanation of subprime mortgage lending in general to give an idea of what this part means:
    http://www.frbsf.org/publications/economics/letter/2001/el2001-38.html

    If you have read the above link, you will better understand the “spillover,” “mess” or “crises” part of it when reading this:
    http://sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/03/18/SUBPRIME.TMP

  2. Reply
    Quake22
    February 7, 2014 at 1:45 pm

    Basically, during the past 5-7 years the housing market was appreciating very quickly. So, mortgage lenders greatly relaxed their underwriting guidelines and offered “subprime” loans (with higher rates than prime loans) to borrowers in scenarios such as (and in many cases a combination of): no money down, recent bankruptcy or foreclosure, bad credit, no income verification and/or no asset verification. The closed loans were then bundled into “mortgage backed securities” and traded on Wall St. and in hedge funds.

    While the housing market was rising, these loans performed well. For example, if you bought a house for $ 200K with no money down and you lived in it for 1 year and it appreciated 10%, you would have had $ 20K in equity so you could sell your house or refinance if you ran into hard times (such as job loss, medical emergency, divorce, etc) Additionally, the investors who bought the loans from the lenders made a ton of money.

    However, now that the housing market has cooled many subprime borrowers are now defaulting. For example, if you bought a house for $ 200K a year ago with no money down, but it depriciated 5% and is now only worth $ 190K (and you still owe $ 200K) and you lose your job and can’t make your mortgage payment, it may be in your best interest to simply default and let it go to foreclosure than try and repay your debt. Therefore, because of the housing market slowing, subprime loans are no longer performing well.

    So the ongoing “spillover or mess” is because these loans are going to continue to default because the housing market is still poor. It has spilled over into the stock market because the mortgage backed securities that are traded are not performing and now investment banks are losing tons of money. Additionally, banks have now learned their lesson of providing credit too easily, so, it is much harder to get credit now (for both homeowners and companies) which is slowing the economy.

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