What's the Big Deal About Subprime Mortgages and High Foreclosure Rates?

It's been all over the news. Mortgage companies are closing their doors! People are running in the streets! Asteroids are headed towards earth!

The media is having a field day with this.

What happened is a direct result of mortgage companies taking risky loans for years. When "subprime" mortgages came onto the scene, it was the answer to many people's prayers. Let me explain what a subprime mortgage is.

Subprime Mortgage
A mortgage that a private company makes to a borrower. These loans are not backed by the government or Fannie Mae. Fannie Mae is the investor for all the loans that your "corner" banks lend. Suprime mortgages are not done at corner banks. They are lent out by large corporations that sell those loans through mortgage brokers.

These private companies decided that they could afford to take the risk of lending to not-very-good credit borrowers. These loans carried high interest rates. To lower the interest rates, they were offered a 2 or 3-year ARM. An ARM is an Adjustable Rate Mortgage. The rate will lock for the first 2 or 3 years. Then the rate goes variable, usually jumping right away. After that time, it was assumed that you would have a better credit score and more equity due to the appreciation of value in your home. Then you could be qualified for a better rate on a refinance mortgage.

We were all wrong. Consumers did not increase their credit scores. In those 2 or 3 years they managed to amass more debt and decrease their credit scores by making late payments on their credit obligations.

We were wrong to think that property values would keep going up as well. Now they've stalled and fallen in many areas. Now consumers don't have that equity they were counting on to help them refinance into a better rate.

People were forced to stay in their current mortgage as it switched from fixed to variable. Many people are now facing rates in the 12% range! Of course, many home owners are having trouble making those new payments and they end up foreclosing on their home.

When someone forecloses on a home, the bank is often the biggest loser of all. They just lent out $150,000 to the owner to buy the place. Knowing that he was being foreclosed on, the owner let the home fall into a bad condition. Now the bank owns a home they can only sell for $120,000. They just lost $30,000 in the blink of an eye.

This has caused trouble for nearly every bank that did these risky loans. Many have closed down. Some have been bought by other companies.

In the next blog I'll explain the end result and what it means to you, the new home buyer.