What is Subprime Crisis? How to solve the subprime crisis?

The current Subprime crisis is not really a crisis due to over lending of banks, but situation
created due to sub prime lending. Banks dont have enough money to lend money. We will start
with subprime lending.

What is sub prime lending?

The term subprime refers to the credit status of the borrower (being less than ideal), not the
interest rate on the loan itself. sub prime is any loan that does not meet prime guidelines.
If your mid fico score is below 620 and you have any mortgage rates within 12 months or recent
BK/foreclosure, you are considered sub prime.

Subprime lending, also called B-paper, near-prime, or second chance lending, is the practice of
making loans to borrowers who do not qualify for the best market interest rates because of
their deficient credit history. The phrase also refers to paper taken on property that cannot be
sold on the primary market, including loans on certain types of investment properties and
certain types of self-employed individuals. Subprime lending is risky for both lenders and
borrowers due to the combination of high interest rates, poor credit history, and adverse
financial situations usually associated with subprime applicants. A subprime loan is offered at a
rate higher than A-paper loans due to the increased risk. (wikipedia ).

What about lending rates?

To avoid the initial hit of higher mortgage payments, most subprime borrowers take out
adjustable-rate mortgages (or ARMs) that give them a lower initial interest rate. But with
potential annual adjustments of 2% or more per year, these loans can end up charging much
more. So a $500,000 loan at a 4% interest rate for 30 years equates to a payment of about
$2,400 a month. But the same loan at 10% for 27 years (after the adjustable period ends)
equates to a payment of $4,470. A 6-percentage-point increase in the rate caused slightly more
than an 85% increase in the payment.

The 2/28 ARM

A very common mortgage in the subprime market, which we have never seen outside of that
market, is the 2/28 ARM. This is an adjustable rate mortgage on which the rate is fixed for 2
years, and then reset to equal the value of a rate index at that time, plus a margin. Because
the margins are high, the rate on most 2/28s will often rise sharply at the 2-year mark, even if
market rates do not change during the period.

For example, the rate is 8% for 2 years but the index is currently 4% and the margin is 6%. If the
index remains at 4% after 2 years, the loan rate will jump to 10%.

Some borrowers with poor credit scores take a 2/28 at a high rate and plan to rebuild their
credit during the 2-year period. Their plan is to refinance at a better rate at that time. The
major threat to such a plan is a prepayment penalty that runs past two years, which some do;
and a lender who fails to report their payment history to the credit reporting agencies.
Borrowers should be on their guard against both.
Who opt subprime lending?

Individuals who have experienced severe financial problems are usually labeled as higher 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 these events were unforeseen and cause a
major setback in finances. As a result, late payments, charge-offs, repossessions and even
foreclosures may result.

Due to these previous credit problems, these individuals may also be precluded from obtaining
any type of loan for an automobile. To meet this demand, lenders have seen that a tiered
pricing arrangement, one which allows these individuals to pay a higher interest rate, may
allow loans which otherwise may not occur.

From a servicing standpoint, these loans have higher collection defaults and experience higher
repossessions and charge offs. Lenders use the higher interest rate to offset these anticipated
higher costs.

Provided a consumer will enter into this arrangement with the understanding that they are
higher risk, and must make diligent efforts to pay, these loans do indeed serve those who
would otherwise be undeserved. The consumer must purchase an automobile which is well
within their means, and carries a payment well within their budget.

How the subprime crisis started?

The subprime lending is 9% in 1996 but in 2004 it is 21%. Due to securitization, investor
appetite for mortgage-backed securities (MBS), and the tendency of rating agencies to assign
investment-grade ratings to MBS, loans with a high risk of default could be originated,
packaged and the risk readily transferred to others. In addition to considering higher-risk
borrowers, lenders have offered increasingly high risk loan options and incentives to them.

Homeowners had been using the increased property value experienced in the housing bubble to
refinance their homes with lower interest rates and take out second mortgages against the
added value to use the funds for consumer spending. Between 1997 and 2006, American home
prices increased by 124%.Easy credit combined with the assumption that housing prices would
continue to appreciate also encouraged many subprime borrowers to obtain ARM they could not
afford after the initial incentive period. With housing prices now depreciating moderately in
many parts of the U.S., refinancing has become difficult, leaving homeowners with higher
payments than anticipated.

Beginning in late 2006, the U.S. subprime mortgage industry entered what many observers have
begun to refer to as a meltdown. A steep rise in the rate of subprime mortgage foreclosures
has caused more than 100 subprime mortgage lenders to fail or file for bankruptcy, most
prominently New Century Financial Corporation, previously the USAs second biggest subprime
lender.The failure of these companies has caused prices in the $6.5 trillion mortgage backed
securities market to collapse, threatening broader impacts on the U.S. housing market and
economy as a whole.

However, the crisis has had far-reaching consequences across the world. Sub-prime debts were
repackaged by banks and trading houses into attractive-looking investment vehicles and
securities that were snapped up by banks, traders and hedge funds on the US, European and
Asian markets. Thus when the crisis hit the subprime mortgage industry, those who bought into
the market suddenly found their investments near-valueless. With market paranoia setting in,
banks reined in their lending to each other and to business, leading to rising interest rates and
difficulty in maintaining credit lines. As a result, ordinary, run-of-the-mill and healthy
businesses across the world with no direct connection whatsoever to US sub-prime suddenly
started facing difficulties or even folding due to the banks unwillingness to budge on credit
lines.

As a result

Right now there is liquidity crisis on wall street. Basically, because so many sub prime loans
are in default, Wall Street investors are no longer supplying money to market which lenders use
to lend out over and over again. They make money by originating a loan and selling it to
someone else who pays the lender a premium based on future revenue. If lenders cannot sell
these loans they cannot generate new business. Since guidelines are now so tight, many of
these subprime borrowers will not be able to refinance their loan. They took short term
adjustable loans (2-3yr fixed) which are now adjusting to much higher rates. They cant afford
the new payment and they cant refi either due to no equity or poor credit.

In the UK, some commentators have predicted that the UK housing market will in fact be
largely unaffected by the US subprime crisis, and have classed it as a localized
phenomenon.However, in September 2007 Northern Rock, the UKs fifth largest mortgage
provider, had to seek emergency funding from the Bank of England, the UKs central bank as a
result of problems in international credit markets attributed to the sub-prime lending crisis.

What about solution?

Loan modification, pumping money into market may slow down the crisis.

Establish rescue funds for borrowers facing short-term problems caused by illness,
layoffs or other one-time events.
Establish a bond fund to pay for switching borrowers out of unaffordable ARMs.
Refinance loans for victims of predatory lending. This would involve working with
Fannie Mae, the quasi-governmental corporation.

Changing loan terms is a mess, borrowerand lender must accept to the terms, lenders may be
unwilling to change terms but Fed interference will work out. But lender will accept to change
in terms to avoid foreclosures.

Pumping money into markets, reducing bank reserves may temporarily weaken the crisis, but
these this is two fold operation, pumping money will increase inflation which will results in
increase in subprime lending, and reducing bank reserves to small extent is better but as whole
destabilize the whole financial system.

Here are some guidelines to prevent that from happening to you:

* Never respond favorably to a solicitation without first checking other options. If you deal with
only one loan provider, your prospects are better if you make your selection by throwing a dart
at the yellow pages than by accepting a solicitation.

* Check your eligibility for mainstream financing with mainstream lenders. The easiest way to
do that is on-line. Some sites that I like for this purpose are Eloan.com, Amerisave.com, and
NationalMortgageAlliance.com. These are all Upfront Mortgage Lenders.

* If you cant qualify with any of them, your best bet is an Upfront Mortgage Broker (they are
listed on my web site). They may charge sub-prime applicants a little more because they
require more time. You will know what they charge, however, and you will know that you are
getting the wholesale price posted by the lender, which means you wont be exploited.