Effects Of Financial Crisis On Real Estate Industry

Essay by ozgurmadranUniversity, Bachelor'sA-, March 2011

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Subprime mortgage lending is the origination of residential mortgage loans to customers with impaired credit histories. Typically, these borrowers have lower credit scores and/or other credit deficiencies that prevent them from qualifying for prime mortgages. Subprime borrowers pay premium above the prime market rate in order to compensate the lender for bearing greater default risk. In addition, subprime borrowers pay higher origination and continuous costs, such as applications fees, appraisal fees, mortgage insurance payments, late fees and fines for delinquent payments (FED OF ST. LOUIS, 2007).

The expansion of subprime lending can be attributed to many factors: federal legislation preventing state restrictions on allowable rates and loan features, the tax reform act of 1986, increased demand for and availability of consumer debt, and an increase in subprime securitization. In October 2000, the U.S. Department of Housing and Urban Development (HUD) set forth a new rule that increased the affordable housing goals of government sponsored agencies such as Freddie Mac and Fannie Mae.

In the rule, HUD identifies the subprime market as a way for Fannie Mae and Freddie Mac to meet their goals, and as an area in which more standardization can be created (Kellog, 2008). A subprime loan is given to individuals who have experienced severe financial problems, are usually labeled as high risk and therefore have greater difficulty obtaining credit, especially for large purchases such as automobiles or real estate. These individuals may have had job loss, previous debt or marital problems, or unexpected medical issues, usually unforeseen and causing major financial setbacks. As a result, late payments, charge-offs, repossessions and even bankruptcy or foreclosures may result. Due to these previous credit problems, these individuals may also be precluded from obtaining any type of conventional loan (Anderson, 2008).

Subprime lending...