Sub-prime mortgages are defined by financial and credit profile of consumers to which they are marketed. According to wallstreeet journal, 2006, a subprime mortgage is a form of sub-prime lending whereby loans are extended to consumers without regard to their credit worthiness. Currently, sub-prime mortgage has expanded at a higher rate compared to past where traditional lenders were very careful and had put many restrictions to borrowers on borrowing terms and conditions.
Sub-prime mortgages are associated with many inherent risks, which have adverse effects on both the lender and the borrower. These risks has negatively affected the peaceful co-existence between the two parties involved in that, most of the times they end up becoming enemies due to failure to owner their pledges when it is due. According to U.S department of treasury guidelines issued in 2001, sub-prime borrowers typically have weakened credit histories that include failure of payment, charge off, judgements and bankruptcies.
Having put this in consideration, lenders have sought for various ways of minimizing these risks. One the method used by these lenders is by charging high interest rate on borrowed mortgage alongside imposing various credit enhancements like Private Mortgage Insurance.
In some circumstances, consumers who are given this form of loan might end up being unable to settle the debt due to exorbitant interest rates imposed on them and due to lack of sustained credit worthiness. In other words, the borrowers become ineffective in their capacity to repay back their loans due to lack of ideal standards to be follow in paying back the loan due to the poor mode of lending. The phenomenon has contributed greatly in restrictions on credit and lending terms in world financial markets. Many consumers of subprime mortgages has been forced to pay using their business capital while others have been forced to default or file for bankruptcy and several of them have been acquired. The high interest imposed by the lenders on the loans is aimed at compensating /her for those loans, which are not paid back (http://thehousingtimebomb.blogspot.com/2008/04/so-how-does-higher-libor-rate-impact.html).
On the other hand, those borrowers who maintain a good repayment record can end up recapturing the money market borrowing standards by proving their credit worthiness.
According to Ronger, T. Cole on his article on mortgage market 2007, Feds decision mostly affects the poor in the nation. For instance, when Feds decides to curb down the rate of inflation by increasing the rate of interest, the poor has to suffer since their level of income is low and are the mostly affected by unemployment rate in the world. On the other hand, when the Feds lower the rates to favor the economy, the poor are in the front line in securing job opportunities from the small-scale entrepreneurs who are willing to offer job opportunities at lower rungs of the wage scale. For example, As cited by Robert Reich in his comment on problems in the sub-prime mortgage market, in the late nineties, when the green span bucked conventional economic widow and decided that economy could easily grow fast enough that unemployment dropped to around four percent. The result was to create more jobs for people in the bottom fifth of the income ladder whose income then started rising for the fist time in decades.
Depending on how the Feds manage the credit market, their designs on access to credit facilities also affect the poor borrowers. For instance in early 2000, the lending rates were too low hence, it ended up frustrating banks on deciding where to invest the extra cash, which was at hand. Feds disregarded their lending standards hence these banks ended up in a tidal wave in sub-prime lending to consumers without regard on down payment with mortgage rate of interest that would rise when the prime rate went up. Later, when Feds raised short term interest rates ,seventeen consecutive times catching the poor borrowers in this trap and allowed banks to set for them, many borrowers, for instance in America ended up being bankrupt and Fed did not admit this as their mistake (A journal by William smith 2007).
In recent past, there has developed another body known as Federal Reserve, which is concerned with development of mortgage market and has closely monitored effects of these developments on financial health of mortgage borrowers and lending institutions. Most of sub-prime loans, which has floated in housing credit with adjustable rate mortgage, originated in 20005 and 2006 and problems associated to them started being experienced in half of 2006 (http://www.federalreserve.gov/fomc/minutes/20070918.htm).
Just as it was in the traditional lending system, some investors and lenders in the sub-prime mortgage have started implementing appropriate underwriting standards and change in their risk profile. (William smith 2007; link to comment.). this has consequently affected potential sub-prime mortgage borrowers by giving them many challenges in borrowing.
The securitization has profound effects especially in highly competitive money market whereby investors of home mortgages pack and resell to the would-be workers. The recent innovations has helped to minimize risk profiles to lenders through use of financial instruments such as; mortgage bucked securities for capital market investors, securitization has reduced transaction costs, increased transparency and liquidity. The market has become very proficient in segmenting cash flows of mortgages portfolios into risk batches targeted to investors with differing risk appetite. Therefore, lenders, portfolios managers, and mortgage servicers should be examining how interest increases, real prime-fluctuation and future payments rises can affect delinquencies, default rates, foreclosures and losses. Strategies should be developed to minimize the effects of deteriorating conditions on segment of the portfolios identified as at risk. Lenders should also take care of environmental factors that might affect their mortgages especially volume of sub-prime mortgages underwritten in previous year.
Federal Reserve regulation in Libor market, available at: http://www.federalreserve.gov/fomc/minutes/20070918.htm, accessed on June 29, 2008 Effects of sub-prime mortgages on Libor markets, available at:
http://thehousingtimebomb.blogspot.com/2008/04/so-how-does-higher-libor-rate-impact.html, accessed on June 29, 2008