The Increasing Of The Subprime Mortgage Market

Published Date: 02 Nov 2017

U.S. house price increase substantially since 1990. The Standard Poor’s Case-Shiller Home Price Indices shows a significantly larger increase in house price that starting in 1988 and it peaked in 2006. Between 1997 and 2006, U.S. house price increased by 124% ("Economist")

Lots of things help to bring up the house price. Under the increasing pressure from the Clinton Administration to expand mortgage loans among low income family, Fannie Mae started to encourage financial institutions to offer home loans even to people who do not qualify for traditional loans( STEVEN A ). The Taxpayer Relief Act 1997 offer tax relief for people on the profit gained from the sale of their house, the passes of the American Dream Down Payment Act that provide funds for downpayment and closing cost to fist-time low-income homebuyers("American Dream Downpayment Initiative") which further stimulate the home ownership. As the result, People start spending more and borrowing more, speculators start investing in second homes and investment properties. A report from Bureau of Economic Analysis indicate that saving rate is steadily declining(Figure1) and the consumer and mortgage debts increase to 133% of disposable income in 2008(figure 2). U.S. homeownership rate now reaches 66.1% ("State & County QuickFacts").

After 2006, house price began to decline to its present level and housing bubble start bursting. By September 2008, the house price declined by over 20% from the 2006 peak (figer 3). This unexpected decline caused borrowers have zero or negative equity in their houses which means the value of the mortgage loans are less than the house value. About 23% total U.S. mortgage holders their house worth less value than the mortgage loan (Louis ).

Under this situation the probability that borrowers might default on their mortgages increased. According to the Department of Commerce, in 2007 the sales of new house declined by 26.4 % to 774,000("Associated Press").

Realty Trac TM U.S. Foreclosure Market Reports, there are about 846,982 properties entering some stage of foreclosure in 2005 and more than 1.2 million foreclosure filings were reported nationwide in 2006 which means for every 92 U.S. households there is one foreclosure filing(White). The burst of the U.S. housing bubble triggered the subprime mortgage crisis which led to the 2007-2008 financial crisis and subsequent recession.

Increasing of the Subprime Mortgage Market

Increase in high risk subprime mortgage loans during the housing bubble is one of the major causes of the subprime mortgages crisis. With the low interest rates, innovative financing option and the support of the government, mortgages qualification becomes more and more loosely. Banks lend money to the borrowers without concern for whether they have the ability to repay the loans. According to a National Association of realtors report, during the housing bubble period, 43% of first time home buyers purchased their house with a zero down payment loans (Knox ).

Income verified assets loans (SIVA) makes people easier to get a mortgage loan. In order to get SIVA, borrowers only need to verbally state their income status. No income, verified assets loan (NIVA) makes borrowers no longer need to be in employment as long as borrowers show some proofs that they have money in their bank account. No Income No Asset (NINA) loans provide loan to borrowers without proof or even state anything, except a credit score.

Adjustable rate mortgage (ARM), the most popular loan. ARM is a mortgage with an interest rate and monthly payment adjust annually in response to changes in the market conditions. (Kidwell, Blackwell, Whidbee, and Sias 274).

ARM has a lower starter rates and interest-only ARM even allows the borrower pay only the interest during an initial period. Under such loose mortgages qualification, some borrowers grabbed this opportunity of cheap credit to take on debt that they don’t have the ability to repay.

American CoreLogic study shows that one-third of ARMs taken out between 2004 to 2006 began with a rates below 4% and payments on these loans will double on average (Arnold). ARM was initially designed to borrower who will live in their homes for few years and then sell at a profit or refinance. Now these loans were made to borrowers with poor credit with higher interest rates to compensate for the risks. A study shows in 2005, almost 23% of all mortgage originated were interest-only ARMs (Arnold). At 2006, the percentage of subprime loan to the total mortgage. originations had increased to about 25%. There are about 7.75 million outstanding subprime mortgage loans in later 2007 which counted 14% of the overall mortgage market (Kroszner). From 1994 to 2006, subprime lending increased from an $35 billion to $600 billion which counts 20 percent of total family mortgage originations (Bernanke). (Figure 4) .

With housing bubble burst, poor credit borrowers were locked up. The value of their houses became less compared to the value of their mortgages. This created extremely high default rates in the subprime mortgages market. In 2007, more than 3.6 million outstanding subprime ARMs were seriously delinquent and 1.5 million foreclosures were initiated by lenders (Bernanke).

Behind the slump of the U.S housing market, growing subprime mortgage market and significant increased delinquencies and foreclosures, a financial crisis gradually formed.