The Subprime Crisis
The subprime mortgage crisis is an ongoing event likely to affect buyers who purchased homes in the early 2000s for a long time. These effects will translate to changes in the housing market, consumer spending, changes in lending practices, and perhaps, revamping of the home loan system. What is meant by the subprime mortgage crisis is that many home loans taken out during a housing bubble occurring on the two US Coasts, from 2000-2005, were given at a subprime rate, and have now led to extensive foreclosures on home loans, and people having to leave their homes because they can't afford the payments.
The housing bubble, meant that for a time, houses sharply increased in value and consumers often borrowed at a subprime (less than the lowest) rate believing that the price of their homes would rise and they could thus refinance for lower payments. Many people didn't just refinance for lower payments but also for consumer spending. Inflation of house prices meant people in possession of a home suddenly had more equity in their home. They could access some of that equity by refinancing, and spend the money as they chose.
Unfortunately, the bubble began to burst in late 2005 and houses began to decline in price. People who refinanced, especially those who did so with variable interest rates, suddenly had homes valued at much less. Many with variable rates and interest only loans ended up unable to continue making payments on their home, flooding the market with more homes for sale than usual and further lowering home values.
This credit and house price explosion led to a building boom and eventually to a surplus of unsold homes, which caused U.S. housing prices to peak and begin declining in mid-2006. Easy credit, and a belief that house prices would continue to appreciate, had encouraged many subprime borrowers to obtain adjustable-rate mortgages. These mortgages enticed borrowers with a below market interest rate for some predetermined period, followed by market interest rates for the remainder of the mortgage's term.
Borrowers who would not be able to make the higher payments once the initial grace period ended, were planning to refinance their mortgages after a year or two of appreciation. But refinancing became more difficult, once house prices began to decline in many parts of the USA. Borrowers who found themselves unable to escape higher monthly payments by refinancing began to default.
As more borrowers stop paying their mortgage payments, foreclosures and the supply of homes for sale increases. This places downward pressure on housing prices, which further lowers homeowners' equity. The decline in mortgage payments also reduces the value of mortgage-backed securities, which erodes the net worth and financial health of banks. This vicious cycle is at the heart of the crisis.
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