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Understanding The Subprime Mortgage Crisis

By Elizabeth R. Elstien

The American mortgage downturn led to the national banking crisis of 2007, which led to the global economic recession. The subprime mortgage crisis was the main cause of this recession. Follow along and learn what burst the mortgage bubble.

Subprime Mortgages Gone Wild

Prime mortgages are at the best interest (prime) rates for buyer's credit and are given to those with good credit with the rate depending on Fico scores and other factors. Subprime mortgages are mortgages given to homebuyers whose credit is inferior. Often buyers obtaining subprime mortgages do not have enough funds for a full down payment. Risky mortgage loans with little to no property equity included:

Interest-only Loan

Mortgage loans where just the interest is paid each month with no payment on the principle. Interest rates were variable, so when the rates rose before the recession, owners could no longer afford payments/

80/20 Loan

This is actually two loans. Eighty percent is the mortgage loan and 20 percent is a second loan for the down payment thereby avoiding private mortgage insurance. The buyer has to come up with little more than closing costs.

In the first several years of the 21st Century, housing prices were consistently rising meaning buyers save less and spend more. Lenders seemed oblivious to the onslaught of risky loan approvals. Loans were easy to get prompting overextensions by buyers and predatory lending practices. These loans are for short-term use and are meant to be refinanced in a few years. Higher housing costs means buyers save less and spend more.

Housing Values Gone Bad

Soon, as housing prices quickly increased beyond sustainability beginning in 2006 and adjustable-rate mortgage interest rates reset, many homeowners defaulted on their loans. New owners were planning on refinancing when their credit was better or they had amassed down payment funds, yet most were unable to as their home's worth had drastically decreased.

Purchasing with no equity combined with decreased home prices left homeowners seriously underwater and unable to refinance or sell their homes. Defaults were the norm in 2009-2012.

Federal Government Gets Bold

The federal government attempted to alleviate the number of defaults with various programs, such as Home Affordable Modification Program (HAMP) that attempted to modify with lower interest rates for a short period of time. As these programs were largely dependent on the big banks/lenders, fewer homeowners were able to save their home than was hoped. This lead to years of record numbers of short sales by owners trying to sell before foreclosure or foreclosed properties being owned and sold by the banks.

National Crisis Goes Global

Before the housing downturn, national and international entities were readily buying subprime mortgage loans at high rates, as times were good. When higher home prices were no longer sustainable, that brought about a chain of reactions that took down both national and global entities. This left the United States in a recession not seen since the Great Depression.

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