Subprime Mortgage Crisis

Subprime mortgage crisis was one of the first indicators of the financial crisis that engulfed the whole world from the year 2007 till 2010. Before we go ahead and understand what caused the subprime mortgage crisis, let us first know what is a subprime loan. A subprime mortgage is given to those people who have a poor credit rating and are not entitled for conventional mortgage loans. These loans are also known as interest only loans as for the first several years, one only needs to make payments on the interest. After a few years, the principal and the interest is combined which increases the monthly mortgage payments. The people who took these subprime loans had hoped that before the monthly payment increased, they would refinance (read what is refinancing) their homes to be able to make the higher payments. But most of the people were not able to refinance and the housing bubble burst, plummeting the US economy in the worst ever recession since the Great Depression of 1929.

Subprime Mortgage Crisis Explained

If we have to fully understand the subprime mortgage crisis causes, we will have to rewind back to the beginning of this century. The subprime mortgage crisis timeline starts from 2001 when all of a sudden, all the big investment institutions were concerned about where to invest their excess capital. The criteria of obtaining a mortgage loan those days was pretty strict. If you had a high paying job, good credit score, enough collateral etc., you were eligible for a loan, but if you lacked any of these, the chances of getting a mortgage loan were pretty low. But then, a home was always and still is an important part of the great American Dream. This is where the investment firms stepped in. Mortgage backed securities became the buzzword for investors and the process of getting a mortgage loan became easier. There was a time when everyone qualified for a mortgage loan. The transaction proceeded this way. An individual used to get a subprime loan from a broker, who in turn sold it to a bank. The bank then sold the mortgage to the investment firms at the Wall Street. The investment firms bought these low risk loans as the returns were fairly high and the profits could be shared among investors to encourage investors to pump in more money.

Downturn in the Real Estate Market

Until late 2005, everything was going according to the way investment firms had planned it to happen, but in 2006, the high interest rates depreciated the value of many homes in the US and people were not left with enough equity to pay off their loans. As mentioned before, one of the reasons people bought these subprime loans was because they thought that with time, their homes would appreciate and refinancing will not only help them in their loans, but would leave enough money for other debts like credit card debts, remodeling of the home, etc. But all these plans went for a toss as falling prices left close to about 23% of the US homes to depreciate. As, people were not able to pay back, the investment firms started the foreclosure activity.

Full Blown Subprime Crisis

The foreclosure of the homes led to an over-supply of homes for sale in the market with little or no buyers. This is when the issue turned into a full blown subprime crisis. The investment firms who had financed these subprime mortgages had invested their money in hedge funds, but after the collapse of the real estate market, hedge funds became worthless. It meant that the lenders of the subprime mortgages too had to file for bankruptcies and foreclosure. The subprime mortgage crisis, an unstable stock market, failed hedge funds and some other global factors contributed to what we now know as economic recession.

The reasons behind the mortgage crisis are so detailed and interconnected with each other that it is very difficult to enlist and explain all of them. But we hope that this article would have helped you get an idea about what is the subprime mortgage crisis and the factors that triggered the sub prime crisis in US.