Subprime Lending: The Problem Behind the Wall

The word “Sub-prime” has been tossed around a lot in the past few months, especially in conjunction with the phrases “real estate” and “recession.” When talking about the housing and stock markets, the sub prime is generally blamed for the recent dip in the economy. The emphasis is placed on the inability of the lenders to collect on their high-risk loans. Sub prime loans are loans targeted at people with low credit scores and bad credit history. The boom in the housing market over the past few years (2001-2005) made lenders more willing to take on high-risk loans in the search for greater profits. “‘Clients started to get harder to come by and the brokers started shaking the trees a little harder,’ says Allen Hardester, director of business development for mortgage broker Guaranteed Rate.” However, the recent downturn in the housing market left many sub prime borrowers forced to default on their loans, and many sub prime lenders were unable to collect any of their investments. Companies such as the New Century Financial Corporation have been forced to shut down or file for bankruptcy because of the prodigious amount of mortgage foreclosures caused by the bursting of the housing bubble.

While most of the spotlight has been shone on the effects of the sub prime rippling throughout the housing markets and in turn the stock market, the sub prime itself is quite a controversial subject. Sub prime lending, by its very nature, targets those who have bad credit histories with credit risk characteristics such as two or more loan payments paid past ninety days due in the last 12 months, foreclosure or repossession. Compounded with the high rates and additional fees used to offset the risk for lenders, this can spell disaster for borrowers. Sub-prime lenders have also been accused of fraudulent and illegal practices. Mortgage fraud in some areas has increased 500% in some areas in just three years. Lenders often try to confuse borrowers with complicated loan terms and take advantage of their lack of knowledge and need to refinance their homes quickly. Sub-prime lenders will even offer sub-prime rates to borrowers that qualify for traditional loans.

Though sub-prime lenders have often taken the blame for unscrupulous activities, the sub-prime also offers an arena in which individuals can improve their credit scores. With the right facts and determination, an individual with bad credit history can use sub-prime loans and credit cards to reestablish their credit by meeting the terms of their contracts. In many cases, random events such as job loss or divorce can impact finances in a large way. The sub-prime gives these individuals a chance to regain their credit when nonsub-prime lenders would merely turn them down. The sub-prime provides an opportunity for an individual with bad credit history to even take out a loan at all.

Recently, the government stepped in and announced a plan to help borrowers in peril from foreclosing. The Federal Housing Administration provides mortgage insurance to borrowers in the private sector, and President George W. Bush has pushed to change policy to allow more homeowners to qualify. Bush also announced plans to reform housing policy in the federal tax code and provide assistance to non-profit groups that offer counseling for foreclosure and refinancing.

Though the situation has obviously gotten out of hand, the federal government’s stance towards the sub-prime borrowers seems lenient. The blame is partially on the borrowers. One of the tenants of a market society is “Let the buyer beware,” and sub-prime borrowers should do the necessary research or hire someone with the proper expertise to ensure what they get is what they want.