Presidential candidate John McCain was asked in an interview "What do you think caused the subprime crisis?" In this article I will touch upon briefly how I would have answered that question.
First off, "subprime" is a term used for the practice of extending loans to borrowers who don't qualify for market interest rates or "prime" rates.
Usually, these borrowers don't qualify for one of two reasons:
This last instance is where the word subprime comes from. It refers to the creditworthiness of the borrowers. In other words, it's less than ideal in the eyes of traditional lenders and entails more risk.
It's not that these individuals can't pay back their loans or aren't worthy of getting loans; they just don't fit the profile of the best type of borrowers. And this applies to many people you may know - people who work in the restaurant, insurance or other commission-based industries may have good incomes, but little documentation.
But the subprime credit risk arises from a combination of factors: bad credit history, high interest rates, and the often dubious financial situations of applicants for subprime loans. Because of the risk, subprime loans are offered at higher interest rates than "A-paper loans."
A-paper loans are conventional mortgage loans given to borrowers who meet the following criteria:
A credit score of 680 or higher
The major lenders in the subprime market concentrated their efforts on borrowers who couldn't meet the A-paper criteria described above. In fact, a now bankrupt major lender (New Century) clearly stated in its performance report to the Securities and Exchange Commission (SEC) that it lent...
"...to individuals whose borrowing needs are generally not fulfilled by traditional financial institutions because they do not satisfy the credit, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers."
At the time, lenders like New Century didn't realize that they were pouring gasoline on a small fire that would soon turn into a huge blaze and cause a meltdown in the housing market. (Other major players included Countrywide Financial Corporation, Ameriquest Mortgage Company, HSBC Holdings Corporation, and Fremont General Corporation.)
All the heavy participants in the subprime market didn't realize they were contributing to a problem that was about to explode for several reasons:
New types of mortgages were created for subprime borrowers, creating yet more business for lenders of installment loans direct lenders. Lenders only make money when they lend it out, and it seemed that the ever-increasing house prices would insure their risk.
Lenders created proprietary automated-underwriting programs that made very quick (and risky) underwriting decisions feasible. They simply blinded themselves to the risky nature of these loans because they wanted to make more and more loans in the white-hot real estate market.
Seeing all of this profitable action in the subprime market. . .
Wall Street and Big Investors Naturally Wanted a Piece
A big piece. So, they created exotic investment vehicles like mortgage-backed security (MBS), asset-backed security (ABS) and collateralized debt obligation (CDO) structures. And those investment vehicles were funded to the tune of billions and billions of dollars. Who knows, your mortgage might be packaged in one of those right now!
In short, everybody involved-borrowers, lenders and investors-had created a bubble of happiness and believed that the good times would roll on forever. They wanted to believe, and then created circumstances that made them believe. Unfortunately, that bubble was about to burst, and burst it did.
I've been investing in real estate since I was 20 years old and as a result, became a multi-millionaire before my 25 birthday. I've enjoyed a successful investing career for 30 years now, and I saw this subprime crisis coming. I see another challenge on the horizon for real estate investors, called "The Uniform Closing Instructions" that are about to affect all real estate investors.
Download my free 48-page report here: [http://www.uniformclosinginstructions.com] to find out more about these new regulations and how they are about to affect your ability to make a profit in creative real estate investing. It will be offered at zero cost for only a limited amount of time.
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