A Silver Lining to the Subprime Mortgage Debacle

The current economic situation leaves much to be desired. Unemployment is up around the country and due to the bank bailout, we are facing a very large deficit, which has questionable returns. This and many other factors lead many to be very wary of what is to come, so it can be hard to find a silver lining. However, for those who are prepared to buy a home, now is a very good time, as home prices are at a historic low and the government is offering a tax credit for first time home buyers.

There are several reasons that house prices are so low, but it has a lot to do with the high rate of foreclosures. Over the last 10 years, the subprime mortgage market exploded.

What are Subprime Mortgages

Subprime mortgages are mortgages that have higher interest rates and less favorable terms than traditional mortgages.

Subprime mortgages have historically been a tool used by people who have less than perfect credit and would not be able to get a standard mortgage. One of the most popular subprime mortgage was the Adjustable Rate mortgage, which had a low initial rate that increases periodically. Not all Adjustable rate mortgages(ARMs) are bad, but subprime ARMs can have an interest rate that increases freuquently and exponentially raises the monthly mortgage payment.

The Role of Subprime Mortgages in the Financial Crisis

Those who receive a subprime mortgage are still usually vetted by the lender, with credit checks and income checks to verify that the individual will be able to pay for the mortgage. However, over the last few years, many lenders stopped vetting loan applicants and instead approving pretty much anyone for a home loan.

Lenders stopped vetting mortgage applicants, because mortgages became a very popular investment tool. Investors would buy up a group of mortgages and then bundle them into a large group. They would then sell the mortgages to investors, many of who were overseas, as a high return investment. Since the bundled mortgages were subprime, they had a much higher than normal return rate.

The first investor, who financed the initial mortgages, would not be keeping the mortgages, so there was no incentive for the investor to vet applicants. Instead, as soon as they had enough mortgages in their bundle, they would sell them and be someone else’s problem. This resulted in many people who should not have had a mortgage ended up with a subprime mortgage.

One of the reasons that real estate became so popular as an investment tool was because of rapidly increasing home prices. Homes would often appreciate more than 25% a year towards the end, which gave the impression that even if the person defaulted on their loan, the home could still be sold for a profit.

This went on for some time, with home prices rapidly increasing, artificially inflated by the large number of subprime mortgages. However, this could not go on for ever and eventually those who received these subprime loans, were no longer able to pay for them, spurring a increase in foreclosures.

The Silver Lining

While the current housing market has brought much sorrow to many homeowners, there is a silver lining for some. With the vast number of foreclosures and empty homes, it is possible to buy a historically low prices. This large number of foreclosures has also driven the prices down on other homes. Further, interest rates are at an all time low.

Of course, lenders are now being much more careful in who they offer mortgages to, but for those with good credit and money for a down payment, it is possible to purchase a new home for much less than even a year ago. The federal government is also offering a tax credit for first time home buyers, which is up to $8,000 and does not need to be repaid, so for many, now is a good time to buy a home.

Many assert that housing prices were artificially inflated in the first place and the prices we see today are simple the real market value of the home, and in many ways this is correct.