Knowing Sub-prime Mortgages
Sub-prime mortgages are mortgages that involve various elements which depart from the usual standards for loans. They may involve higher interest rates, smaller down payments, longer terms, or a lower standard of documentation of the borrower's ability to repay. In all cases, they represent a greater risk to the lending institution that the borrower may not be able to repay the lone completely.
Sub-prime mortgages are often extended to people who have black marks on their credit history or who have a relatively short credit history. For instance, someone who had a major illness that led to large medical bills combined with gaps in their income may have been able to get their feet back under them, but will still have trouble qualifying for a regular loan as a result of the long-term damage that incident did to their credit history. As a result, sub-prime lending is often regarded as a form of credit repair, a way of getting a fresh start and rebuilding a good credit history after a spill that wasn't your fault.
People who have difficulty getting access to credit in the first place often resort to sub-prime lending in order to get their foot in the door. Getting credit the first time can often become a Catch-22 situation -- nobody wants to lend you money when you don't have a credit history, but you can't build that credit history if nobody is willing to lend to you. Racial and ethnic minorities often find themselves in this sort of a jam, since they often don't come from families with a strong history of having and using credit, and thus don't get the leg up that many white families give their kids, for instance by putting a utility bill in their name so that the payments go toward their credit history. Many people went into sub-prime mortgages hoping that within a few years they'd be able to move up to a more traditional mortgage.
However, sub-prime lending also has its ugly downsides. Particularly in the early part of the first decade of the 21st century, sub-prime mortgages became a major locus of predatory lending practices. People were fast-talked into taking on mortgages far larger than they could afford, and in some cases the loan officers outright falsified their income figures on their applications in order to get a larger loan. Even people who had started with traditional mortgages got involved in sub-prime lending in order to cash out all the equity on their homes in the hope that their homes would continue to appreciate in value and they'd soon have equity again. Because many of these financial institutions then resold the mortgages to be packaged into mortgage-based securities, they were able to realize substantial profits and leave someone else with the risk of default.
And when the economy began to go sour, the risk of default proved out. Sub-prime mortgages went into foreclosure at a far higher rate than traditional loans that conformed to underwriting standards. Many of these people simply didn't have the necessary financial depth of field to be able to ride out a rough period. Many of them worked in fields that were very sensitive to economic downturns, and as a result were the first to lose their jobs when things went sour. Others were stretched so thin financially as a result of over-large mortgages and other payments that when gas prices began to skyrocket in the summer of 2008, they became unable to keep up with all their bills and something had to start sliding.
In any case, the problems within the sub-prime lending industry became a self-feeding cycle. Banks began to fail as a result of the bad loans on their books, resulting in panics as people wondered what would happen to their deposits. Fortunately the Federal Deposit Insurance Corporation (FDIC) protected ordinary depositors and prevented wide-spread panics of the sort seen back in the 1930's, when people who weren't in the front of the line in a run on the bank were often left with nothing but a worthless passbook, and many people saw a lifetime of savings wiped out. However, more than a few people had some very unpleasant and uneasy-making days before they were able to get their money, and during that period they often had difficulty paying bills and carrying out their ordinary financial lives if they didn't have cash on hand.
Although sub-prime lending has become connected in the public's mind with the 2008 housing crisis, that relationship is complicated and shouldn't be over-simplified. However, if you are not able to qualify for a regular prime loan, you should think long and hard about just what it is that's holding you back, and whether it's a danger sign that you're getting in over your head.
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