The History of Sub Prime Mortgages

Sub prime mortgages allowed borrowers to buy more expensive houses than they could afford.

Sub prime mortgages were all the rage in the mid 90s and early 2000s, when housing prices were still on the rise. They were created with the assumption that housing prices would continue to rise. But when the financial crisis hit in 2008, sub prime mortgages got a lot of the blame for the ailing economy. So what were they, and how did they cause so much trouble?

Definition

As opposed to a prime mortgage, which requires the borrower to have good credit and to make a substantial down payment, a sub prime mortgage required only a small down payment and was available to borrowers with bad credit.

Terms of a Sub prime Mortgage

Because sub prime loans were seen as riskier, they bore high, often adjustable, interest rates. In order to get borrowers to go for sub prime mortgages, the introductory interest rate would often be low for the first two years, and then enter the "adjustable" period, in which the rate could be hiked up.

Beginnings

The first mortgages with adjustable interest rates were offered in 1981, but sub prime mortgages as they exist today did not become widespread until the mid 90s. Many borrowers were lulled into a false sense of security, and took sub prime mortgages assuming they would be able to sell or refinance their homes before the adjustable interest rate period kicked in.

Lender's protected themselves by backing sub prime mortgages with mortgage-backed securities, which allowed investors to buy some of the debt in exchange for a high rate of return.

Rise in Home Ownership

For a while, housing prices continued to rise, and so did home ownership. In 1994, the U.S. home ownership was 64 percent. Thanks in part to sub prime mortgages, the rate rose to a record 69.2 percent in 2004.

The Crash

But by 2007, overconfidence in the housing market had led to the construction of more homes than were needed. Supply outstripped demand, and housing prices began to fall. Rather than being able to sell or refinance their homes, many people were stuck with mortgages they couldn't afford. When the higher interest rates kicked in, many people could no longer make the monthly payments, and ended up losing their houses. That meant the mortgage back securities lost their values, which precipitated the financial crisis.

When the financial crisis hit in 2008, the media started taking an interest in the history of sub prime mortgages, because in hindsight they seemed like a disaster waiting to happen.

References

• HUD: Subprime Lending
• "The New York Times:" 'Irresponsible' Mortgages Have Opened Doors to Many of the Excluded
• Federal Reserve Bank of Dallas: The Rise and Fall of Subprime Mortgages

Resources

• "The Frontal Cortex:" Patience