Sub-Prime Mortgage Crisis

By: Jessica L. Wright

A long-term trend of rising housing prices and loan incentives encouraged borrowers to assume mortgages leading them to believe they would be able to refinance at more favorable terms later. Until recently, those borrowers who had good credit and paid their bills on time were viewed as the safeguard against those borrowers who had bad credit and who did not pay their bills on time. However, when the housing market began to drop dramatically in 2006-2007 the ultimate result was how difficult it would become for borrowers in their refinancing.  Like subprime mortgages, many prime loans allowed borrowers to initially pay less and then pay higher adjustable payments years later. As long as home prices were increasing this allowed for borrowers to refinance their loans or to sell and pay off their mortgages.

However, as Adjusted Rate Mortgages (ARM) rates increased, default and foreclosure rates soon followed step. The high foreclosure rates resulted in the subprime mortgage crisis triggering a financial crisis in 2007 and 2008. Subprime loans are typically given to those who have a tarnished or limited credit history. It is because of this limited credit history that the loan rate is typically higher than a regular "prime" rate would be for an individual without a limited credit history. Due to the high foreclosure rate over the past few years' lenders are tightening their loan policies of who is to receive any type of loan.

This leads to an important question: Will it be harder to obtain a mortgage if you don't have much of a credit history or a bad credit history? The answer to both of these is simply, yes. Lenders are going to be less willing on taking risks on borrowers because the recent housing boom has put those lenders in a financial crisis. Unlike subprime borrowers, who tend to have lower incomes and fewer assets, prime borrowers have a greater chance to restructure their debt if they face financial challenges; this is not so for those subprime borrowers.

The U.S. Legislators and the U.S. Treasury Department are taking action due to this economic downward spiral. The U.S. Federal Reserve has cut interest rates and President Bush signed the Economic Stimulus Package into Congress on February 13, 2008; both of which are designed to stimulate economic growth and inspire confidence in the financial market. The Economic Stimulus Package is intended to boost the U.S. economy in 2008 and to restructure or avert a recession. Furthermore, this Act provides for tax rebates to those having low or middle income, tax incentives to stimulate business investment, and an increase in the limits imposed on mortgages eligible for purchase by government-sponsored enterprises. The rationale behind signing into law the Economic Stimulus Package is the hope that the targeted individual tax rebates would boost consumer spending and that targeted tax incentives would boost business spending. Some are hopeful the economy will bounce back but others are skeptical. For now, one thing seems to be clear: many people are only spending what they need to and cutting back on the so-called little luxuries of life.