What are Subprime Mortgages?
A subprime mortgage is a loan secured by real estate and issued to a credit-worthy borrower. Subprime borrowers have a history of delinquent payments, large loan-to-values (low up-front deposits) or large loan-to-income ratios. A typical subprime loan could be structured as 30-year 2-28 adjustable-rate mortgage (ARM). This product comes with a 2-year relatively low fixed teaser rate, which reverts to a much higher variable rate for the remaining 28 years of the mortgage.
Because of the high demand for subprime mortgages, some lenders and mortgage brokers engaged in unethical tactics. In most cases, the remuneration structure for originating a mortgage was centred on the number of mortgages rather than their quality. The eligibility of a mortgage for a specific borrower was frequently overlooked, resulting in numerous subprime mortgages being sold to persons who could not afford them or who could qualify for less expensive products.
Example of Subprime Mortgages:
The subprime mortgage crisis triggered hedge funds, banks, and insurance firms. Hedge funds and banks produced Mortgage-backed securities. The insurance companies used credit default swaps to protect them. The high demand for mortgages resulted in a home asset bubble.
- Hedge Funds Played a Key Role in the Crisis
- Derivatives Drove the Subprime Crisis
- Collateralized Debt Obligations
- Downturn in Real Estate Prices Triggered Disaster
Why are Subprime Mortgages important?
Subprime Mortgage was one of the critical reasons for the financial crisis in 2008-09. In risk management, we learn from our experience. Hence, it is essential to know what subprime mortgage was so that risk professionals can avoid dwelling on such a thing with short-term gain and long-term loss strategy.