Credit Crunch and Sub Prime Mortgages

I would be interested in reading your thoughts on the following post. Basically she says the credit crunch is not really a subprime problem but an ARM problem. What do you think?- link to article: All

It is certainly the case that the problems in the US Housing Market are partly due to ARM (Adjustable Rate Mortgages). In particular, many banks were lending at low introductory rates and then increasing the rate after the initial period. This problem was then exacerbated by rises in the Fed rate. It is quite interesting that the statistics suggest a low % of sub prime mortgages are ARM.

In this blog entry, I gave an example of a Teaser Mortgage, which was sold to someone who just couldn’t afford it.

This is an extreme example of bad lending practise, that seems to have become more prevalent in the past 7 years.

In the cases like this we have to put a large portion of the blame on mortgage lenders who have encouraged / allowed their salesman to sell loans without the proper checks. From what I know, this kind of irresponsible lending has not been confined to the sub prime sector.

Although, perhaps the sub prime lending has been more prone to other bad lending practices.

The main contribution of sub prime mortgages to the credit crunch is that they have affected market sentiment, quite significantly.

Sub Prime Mortgage companies experienced problems because:

  • Rising interest rates set by Fed
  • People took out loans which were unsuitable, too high for their income.
  • House price growth slowed, then fell

When mortgage defaults increased and sub-prime mortgage dealers went out of business, this had a knock on effect to other related financial groups.

Sub prime mortgage debt was often passed onto other financial institutions. As a consequence they have had to write off a lot of debt. This means generally the mortgage industry is much less keen to lend. – At least, it is making people think of responsible lending.

– In the UK, the problem isn’t quite as severe because mortgage lending, even in the sub-prime sector, was generally more stringent.