We have all been hearing a great deal of discussion regarding subprime mortgage lending in the past few weeks, and many people are asking…What is subprime lending and how does it affect me?
According to Wikipedia, SUBPRIME describes a specific lending market sector. Typically, subprime customers are those who do not qualify for prime market rates because of blemished or limited credit. Consequently, subprime customers are charged a higher interest rate to compensate for the increased risk. The general lending philosophy can be described as "priced to risk"; the higher the risk on the deal, the higher the interest rate. Statistically, approximately 25% of the population falls into this category.
It has been suggested that the recent fall in the stock market is somehow associated with the subprime issue. There has also been mention of a possible collapse in this area of the mortgage market and hence, a greater difficulty in getting mortgage financing.
Yes, the foreclosure rate in this market segment has recently been rising. It is probable that these types of loans will not be written as aggressively in the future as they have in the past. It has been noted by Baird and Warner’s Financial Services Senior Vice President/Chief Operating Officer Donna Burge, the changes that are occurring right now are being driven by 3 factors:
1. Federal bank regulations introduced last fall requiring stricter underwriting guidelines and risk-based pricing
2. A significant increase in delinquencies and defaults in sub-prime portfolios, requiring increased reserves and earnings adjustments
3. Wall Street prices for sub-prime mortgages have declined dramatically, diminishing both the value and outlet for this product.
What does this mean for borrowers? Several subprime lenders have already, or will soon go “belly up”. Most of America’s financial institutions will not experience any serious disruption of business or severe financial losses because they do not have a great deal of exposure to the subprime marketplace. Most traditional mortgage products will continue to be available to borrowers. Stay tuned to see how this story plays out.
