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Economic Effects of Sub-Prime Lending

In: Business and Management

Submitted By winnie1234
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Economic effects of subprime lending A subprime lending is an option for individuals that have difficulty meeting mortgage payment schedules or for individuals who have low credit scores and considered risky borrowers. For example, an applicant with a low credit score of 500 will have a very difficult time locating a loan. Subprime lending comes with a high cost to borrowers. Lenders see bad credit applicants as riskier than applicants with better credit scores. Borrowers in turn pay for this risk by accepting loans with a higher interest rate. Subprime lenders offered the realization of the American dream of home ownership to borrowers who would otherwise be denied credit. Interest only loan options were offered, and combined with the mortgage-backed securities (MBS) added so much liquidity that in turn created a housing boom. Over time borrowers end up paying higher interest rates with zero payment application against their loan amount. Unemployment setbacks that ultimately resulted in defaults, added to the economic crisis. Consequently, more homes were placed in a market that is already saturated with newly constructed homes. This created less demand resulting to more houses that builders were unable to sell. Controls of banking rules and regulations during the 1980’s were relaxed, and monitoring policies for these were not the highest priority. Jimmy Carter’s “Depository Institutions Deregulation and Monetary Control Act of 1980” was a window for financial institutions to continue their momentum of relaxed lending practices. Yet another regulatory policy under the “Gramm-Leach-Bliley Act of 1999” was passed that removed barriers between banks and mortgage investment lenders. This regulation was viewed as pivotal to the economic crisis as it allowed commercial banks, investment groups, security companies and insurance groups to merge and package an…...

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