Dangers of Sub Prime mortgages

In the past week headlines about the US mortgage industry have dominated the news. In particular the number of defaults on mortgage payments is growing very rapidly. These defaults are concentrated on the sub prime sector. These mortgages are aimed at those with bad credit or non-status. Often these mortgages are approved without making any checks about the income status of the borrower. In the UK there has been a similar increase in the number of self-certification mortgages and other non-conventional mortgages.

The growth in sub prime mortgages has been very significant. In the US it has allowed over 6 million people to be able to buy a house for the first time. However the success of the sub prime market was mostly dependent on rising house prices. Rising house prices enabled borrowers to remortgage (refinance); this means that after a couple of years they were able to switch their mortgage and get a better deal. Rising house prices were particularly important for people who were getting 100% mortgages. This is a mortgage with no deposit. Because of the risk traditionally these 100% mortgages lead to higher interest payments. However if house prices rise it means the mortgage becomes a smaller % of the value of the house.

Unfortunately the situation is that US house prices are now falling. This means that homeowners are unable to remortgage and in many cases are left with negative equity. (house worth less than the mortgage debt)

Dangers of “Teaser” Mortgage Terms.

Another feature of sub prime mortgages is that often there was a special introductory rate to make mortgages more attractive. For example in the first year or two the interest rate on the mortgage was much lower than subsequently, this had the effect of encouraging borrowers to take on a mortgage that becomes increasingly difficult to pay back. Therefore as more sub prime mortgages reach the end of their introductory period the number of defaults is likely to grow.

The Guardian (16th March 2007) report the story of Simeon Ferguson an 85 year old father with dementia. Unwittingly he took on a new mortgage with a fixed rate for 30 years. The introductory teaser rate offered him a monthly payment of $1,482, however after 3 years this jumps to $4,200. It is only at this point that the mortgage involves capital repayment. However the pension of Simeon Ferguson is only $1,100 a month. This is an extreme example of how US mortgage companies have been willing to ignore the most basic of credit checks in order to be able to sell as many mortgages as possible.

from Guardian