What is sub-prime lending?

#1
Sub-prime lending usually refers to the practice of giving loans to those who do not qualify for regular loans at market interest rates because of their poor credit history. Due to the increased risk associated with the takers, sub-prime loans are offered at a rate higher than market rates.

These loans are risky for both, those who are giving and those who are taking, because these combine high interest rates, bad credit history, and often, murky financial situations of the takers.

The current sub-prime mortgage meltdown in US refers to the rash of sub-prime housing loan defaults that began in late 2006 and has continued into 2007. The sharp rise in foreclosures has caused several major sub-prime mortgage lenders to shut down or file for bankruptcy, leading to the collapse of stock prices for many in the subprime mortgage industry.

About 21% of all mortgages between 2004 and 2006 were sub-prime, up from 9% during the previous eight years. By 2006, sub-prime mortgages totalled $600 billion, accounting for about 20% of US home loan market.
Note: there are also sub-prime mortgages. This is when people borrow against the increased value of their homes, often to pay off other borrowings.

The term can also apply to mortgages taken out by people who are not attractive to mainstream lenders because of their credit history or employment status.

So why all the worry?

Well, New Century Financial - a major sub-prime lender in the US - has had its shares suspended on the New York Stock Exchange. New Century has been hit by a rise in default rates in the sub-prime sector, meaning fewer of its customers have been able to keep up with mortgage and loan repayments.

A slowdown in the US housing market coupled with rising US interest rates have also hit the company. New Century is not alone, though.

Sub-prime lender Accredited Home Lenders Holding saw more than 75% wiped off its value in two days after it revealed that it may have to raise extra funds, seek debt waivers, cut jobs and put back its earnings announcement.

And UK banking giant HSBC has been struggling with bad-debt provisions in the US since it bought sub-prime lender Household International, which it renamed HSBC Finance. HSBC revealed earlier this month that its bad debt provisions for 2006 would be about $10.5bn (5bn) - largely because of mortgage defaults.

But isn't it risky to lend money to people with a poor credit history?

Yes, the risks to the lender are higher than is the case with a mainstream loan. However, the level of bad debts recorded by most sub-prime lenders had, until recently, been relatively low. Traditionally, the big UK retail banks have steered clear of sub-prime lending.

But some big names such as HSBC, RBS and Alliance & Leicester have been targeting the sub-prime market. Adverts offering loans and mortgages to people with poor credit histories are widespread on cable and satellite TV channels.

However, reports last year suggested that Britain's Financial Services Authority (FSA) was becoming worried at the amount of money flooding into the sub-prime market.

It suggested that investment banks - which help fund the sub-prime market - could get their fingers burnt if the economy were to suffer a downturn.

Do sub-prime lenders charge a premium?

Yes, they do. They argue that they have to do this to reflect the greater risk of borrowers defaulting.

How big is the sub-prime market?

Investment bank Merrill Lynch has estimated that the sub-prime mortgage market in the UK alone was worth between 25bn and 30bn in 2005.

According to market analyst group Datamonitor, mainstream mortgage lending grew by 4.1% in the year previous to that, while sub-prime mortgage lending rose 9.1% for the period.

Until recently, the future of the sub-prime sector had looked rosy.

But the troubles besetting New Century Financial in the US, and higher interest rates in the US, UK and across Europe, have raised concerns in some corners about the long-term viability of the industry.


U.S. sub-prime mortgage crisis


Beginning in late 2006, the U.S. sub-prime mortgage industry entered what many observers have begun to refer to as a meltdown. A steep rise in the rate of sub-prime mortgage foreclosures has caused more than two dozen sub-prime mortgage lenders, which includes home lender giants like New Century Financial Corporation, Countrywide Financial Corporation, Ameriquest Mortgage and HSBC Holdings Plc. to fail or file for bankruptcy. The failure of these companies has caused stock prices in the $6.5 trillion mortgage bundled securities market to collapse, threatening broader impacts on the U.S. housing market and economy as a whole. The crisis is ongoing and has received considerable attention from the U.S. media and from lawmakers in the early part of 2007.


Borrowers have also been criticized for entering into loan agreements they could not meet. Many accounts of the crisis also highlight the role of falling home prices since 2005. As housing prices rose from 2000 to 2005, borrowers having difficulty meeting their payments were still building equity, thus making it easier for them to refinance or sell their homes. But as home prices have weakened in many parts of the country, these strategies have become less available to sub-prime borrowers.


Several industry experts have suggested that the crisis may soon worsen. Other experts have raised concerns that the crisis may spread to the so-called Alternative-A (Alt-A) mortgage sector, which makes loans to borrowers with better credit than sub-prime borrowers at not quite prime rates.


Some economists, including former Federal Reserve Board chairman Alan Greenspan, have expressed concerns that the sub-prime mortgage crisis will impact the housing industry and even the entire U.S. economy. In such a scenario, anticipated defaults on sub-prime mortgages and tighter lending standards could combine to drive down home values, making homeowners feel less wealthy and thus contributing to a gradual decline in spending that weakens the economy. Other economists doubt home prices will fall dramatically because most owners won't have to sell, but still predicts home values will remain flat or slightly depressed for the next three or four years.


As the crisis has unfolded and predictions about it strengthening have increased, some Democratic lawmakers have suggested that the U.S. government should offer funding to help troubled borrowers avoid losing their homes. Some economists criticize the proposed suggestion, saying it could have the effect of causing more defaults or encouraging more risk lending.


This crisis has resulted in melting down of stock prices of many Home Lending companies like Accredited Home Lenders Holding Co. were down by almost 20% yesterday.

 

kkseal

Well-Known Member
#2
Well, our own traditional subprime lenders - the village mahajans - have done well for themselves over centuries. Even the modern day Alt-A lenders like DEWAN HSG, SHRIRAM TRANSPORT FIN are doing quite well; Md. Yunus has not only done well but bagged the Noble prize for his (sub-prime) microfinance model.

Who says we can't beat the 'developed idiots'? :)

Regards,
Kalyan.
 

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