Case Study: Subprime Loans

Case Study: Subprime Loans

Introduction

After the financial industry has floated $190 billion to save Fannie Mae and Freddie Mac from being collapse in 2007 is not a wise thought in the financial market. The FHA is now expected to survive the year without taxpayer assistance. If the economy deteriorates, however, it will not be able to slip under the public's radar for long.

Therefore it is commonly termed as “Mortgage Meltdown”. Just after the collapse of Lehman Brothers and other strong financial institutions in the world leading financial market open the eyes of economists and financial planners that's what is going wrong. After a complete analysis they all agree on same terminology that is “Sub-Prime Loans” and blame it to be one of the main reasons for the financial crises of 2007 - 2008.

The subprime crisis broke out in the second half of 2006 with the crash of loans (mortgages) borrowed by the subprime buyers, banks and financial institutions advance loans in order to boost up their business. But this boost up would turn the whole situation and the sub-prime users feel helpless in the situation. Extensive lending and less recovery would make the financial institutions to stick in the liquidity problem. The problem would become severe soon when the subprime borrower starts showing defaults.

The increasing rate of subprime loans is causing ripple effects in the international stock markets. Most of the financial guru's link subprime loans with ethics. Subprime customers are those whose credit rating is below 570 i.e. acceptable ratings. The mortgage lenders target them as their potential customers and advance loans to them at greater interest rates as compared to the prime lenders. This trend of lending to sub-prime customers becomes common whereas on the other hand it gives rise to defaults.

Financial critics termed it as an unethical practice because the lender is not complying with the acceptable ratings i.e. 570 and it means that knowing the fact that the customer will not be able to pay-off its debt then again the mortgage banks advance loans to them even knowing the fact that they would default in the near future. The housing industry become the victim of sub-prime loans as well as, it has a great impact on stock value of these mortgage loans. If we analyze the impact of sub-prime loans on the stock market it can be clearly witnessed that they the stock market falls by 18% within a single week.

The major learning outcome in this scenario is that the sub-prime loans needs to be avoided in order to save the financial market from the ripple or bubble effect. FHA was set up to make mortgages available during the Depression. The major reason why these loans are so common is that it requires a little verification of income.

Answer

The study shows that there are some 38% of the borrowers who are actually able to borrow loans in the prime market but they borrow from the subprime market because of the reason that ...