Sub-prime mortgages - the ins and outs

With an increasing amount of distressed property making its way on to the US market, we take a look at one of the major contributors to the housing crisis. What is a sub-prime mortgage?

With an increasing amount of distressed property making its way on to the US market, we take a look at one of the major contributors to the housing crisis.

What is a sub-prime mortgage?

A sub-prime mortgage is a property loan which is granted to individuals who have a poor credit history that prevents them from being able to access a conventional mortgage. Because of this the interest rates charged by lenders tend to be in excess of the prime lending rate.

The Good

The emergence of sub-prime mortgages has opened up home ownership to an increasing number of individuals who previously would not have been able to afford it. Because of this it has enabled a new type of buyer to enter the market who previously would have been priced out. This ability to own property also has a significant effect on building people's wealth - home equity tends to be the primary method of saving for many individuals.

The Bad

As the old saying goes, "If it sounds too good to be true, it probably is". Such is the case with subprime mortgages and their downfall lies in their cost. Because by nature they are more high-risk, the cost involved is more than an ordinary mortgage. Higher interest rates are generally combined with prepayment plans and additional penalties.

Furthermore, because sub-prime mortgage borrowers tend to be the less affluent members of society, they usually have higher default rates than their "non sub" counterparts. Combined with rising interest rates, this could see the emergence of a situation where the market becomes flooded with foreclosed properties.

Making matters worse is the fact that the vast majority of sub-prime borrowers have adjustable rate mortgages. This means they qualified for the mortgage at low, introductory rates and over a short period of time the rate has increased substantially.

The Result

The latest figures released by RealtyTrac show that in the US there was a seven per cent increase in the amount of foreclosures in the country during the first quarter of 2010 - a trend which can be attributed to a large number of homeowners defaulting on their mortgage payments.

As mentioned earlier, sub-prime mortgages do open up the opportunity to enter the property market to individuals who would previously have been unable to, but the problem lies with borrowers who remain unsure of what they are signing up for and what they are committing to pay.ADNFCR-3415-ID-19750714-ADNFCR

- Friday 30 April 2010

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