A subprime mortgage lender is a lending institution which offers mortgages to those individuals who may not be able to otherwise qualify for a mortgage. The borrower tends to be higher risk, and therefore the rate at which the mortgage is made tends to be higher.
Many subprime mortgages have an interest rate adjustment feature. At a certain time, the mortgage rate will adjust (usually up) and then remain fixed for the remaining life of the loan.
The problems begin when the mortgage rate is due to rise, and the borrower, who was counting on refinancing the mortgage because of an assumed increase in housing prices, now cannot refinance because housing prices have leveled off or even fallen. At this point, the borrower cannot pay the new, higher mortgage rate on the home, and the home's ownership transfers to the bank. Banks are not interested in being homeowners, and the banks often put that home up for sale immediately.
Currently, the combination of falling home prices and rising mortgage rate adjustments has translated into a credit nightmare which has spilled over into the general economy, affecting the stock, bond, and housing markets. Certain lenders are offering to "freeze" the mortgage payment instead of letting it adjust higher, which should help some of the borrowers.
The other side of the equation is the investor- often times a city, state, pension/profit share plan, or individual. That investor purchased a mortgage investment and assumed it would carry a low interest rate for a short period of time and then a higher interest rate for the balance of its life. When the interest rate does not adjust up, the investor is left with an investment worth far less than originally thought.
Blue Haven Capital expects to see continued weakness in the housing market in 2008 despite lower interest rates. We do not recommend investing in the subprime mortgage market since the instruments themselves are under pressure by the government to hold off on adjusting to higher rates.