How You Can Survive Sub-Prime and Mortgage Meltdown

There are many causes for the current mortgage crisis in the US and financial meltdown worldwide. This article focuses on the subprime mortgage crisis and how it contributed to the financial meltdown. The mortgage crisis is one major cause for the financial meltdown.

For Decades, the type of loan a borrower would qualify solely depended on the borrowers FICO (Fair Isaac Company) score and loans were provided. A subprime loan will usually have higher interest rates than the conventional loans and were provided with no documentation or a stated income of the borrowers.

The subprime mortgages encouraged people to purchase houses that they could not afford based on their FICO score and income and savings. Many of them obtained 100% financing i.e., they did not pay a down payment for the house. This is risky as these homeowners were living almost on a month-to-month paycheck. Until the end of 2006 and early 2007, such loans were available for people with FICO scores of less than 620.

Soon, the homeowners’ inability to repay the loans made the lending institutions to increase the required FICO to 640. Still, many homeowners were unable to repay the loans and soon the subprime mortgage crisis began when the foreclosure rates increased nationally. Foreclosures are usually a loss for the bank because they end owning these properties. It is a loss even if the lenders end up selling the foreclosed homes. This is not an ideal situation.

During the real estate boom period, overbuilding lead to excess number of houses (excess inventory). As expected, the housing prices dropped end of year 2005 through middle of 2006.

There were many refinance options available so a lot of homeowners who purchased homes at higher interest rates were able to refinance at a lower rate. Between years 2006 and 2007, the real estate prices dropped again and the interest rate began to increase. The homeowners who hoped to refinance at lower rates could not find any lower rates. Some stats are varying but on an average during the year 2007, there were around 1,350,000 foreclosures in the US.

As the rate of foreclosures began to soar, the mortgage companies, investments firms and all those institutions that invested in subprime mortgages began to fail. This crisis is characterized by contracted liquidity in worldwide markets and banks. All these happened because weak global financial system and weak (and lack of) regulations that included the housing and credit systems. Some of the smaller financial institutions began to fail initially. Globally, over $400 billion losses were reported by financial institutions.

As of March 2008, around 11% of the homeowners had negative or zero equity (no equity) because their homes were worth less than their purchase price. The best option for them was to foreclose their home despite the negative rate impact. Some homeowners were able to sell off their home to pay the banks but most of them foreclosed.

There was surplus of homes. Research reports indicated that the home prices dropped by 18% in May 2008 compared to the previous year. This was after the 26% drop in 2007 compared to 2006. The bigger loss came to people who had purchased properties for investment. One example is that in Miami, FL, 85% of the real estate purchased was for investment purposes.

These were some of the reasons of the mortgage crisis. This article emphasizes on one aspect of the subprime crisis i.e., mortgage. While some believe that the practices of subprime lender and inadequate governance led to this crisis, others believe that the greedy mortgage brokers attracted borrowers to loans which were well beyond the borrowers’ means, and still some others blame the appraisers for falsely inflating the housing values. It is well known from the news that the Wall Street backed the subprime mortgage securities without doing their due diligence of determining the loan strength. Of Course some blame goes to the borrowers for signing up for loans that they clearly could not afford.

The lessons learned here are not to purchase a home if you cannot afford it, assess your financial situation rather than relying entirely on the mortgage broker’s assessment and also get advice from reliable friends, relatives and financial planners about your ability to buy a house. As a rule a house should be purchased if you have enough savings to make six - eight months of mortgage payments. This amount of saving will come handy in case of job loss and other financial disasters.



Stephan Iscoe
Publisher,
MoneyMakersNews.com

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