It is no secret that the subprime lending crisis of 2007 to 2010 began due to a surge in subprime lending and the large amount of risks that were associated with subprime mortgages. However, it is important to understand subprime lending before being able to analyze the risks that were imposed on the lenders as well as the borrowers.

Subprime lending refers to the creditworthiness or credit characteristics of individual borrowers. Subprime borrowers are generally individuals with poor credit, low income, or limited documentation, who generally wouldn’t qualify for a mortgage at standard market rates. Subprime borrowers have weakened credit histories that often include payment delinquencies, and sometimes more severe problems such as charge-offs, judgements, and bankruptcy filing within the past five years. They often also display reduced repayment capacity as measured by their credit scores which is generally having a FICO (Fair Isaac & Co.) in the range of scores less than 660, debt-to-income ratios in excess of 50 percent, or other criteria that may encompass borrowers with incomplete credit histories (Brauneis & Stachowicz, 2007).

Gilbert (2011) describes subprime loan as a type of loan that is offered to individuals who do not qualify for prime rate loans and at a rate above prime. Subprime loans offered a new source of potential profits to lenders and created opportunity for less credit worthy consumers to obtain loans that would have been normally been out of their reach (Watkins, 2011). The issuing of subprime loans were more to the point of the Goldman Rule as a pursuit of profitable opportunities by lenders regardless of the effect it had on others and a tradeoff between profitable opportunities and social ethics (Watkins, 2011).

A great visual aid to understanding the subprime loan crisis can be viewed in the short video “The Crisis of Credit Visualized” which is educational and entertaining and helps to ingrain and summarize the crisis in a very straightforward manner (Jarvis, 2012).

Although subprime lending increases the number of people who can buy homes, it makes it more likely for those people that do so to incur more risk to their financial situation and increases the chances that they will default on their loans. The subprime loans posed varying risks to lenders and borrowers. The appreciation in home values made subprime loans appear risk-free (Watkins, 2011). However, the borrowers who obtained subprime loans risked foreclosure or default and bad or worsening credit. It also put lenders at risk of the loss of associated collateral. Defaulting hurts both the borrower (in terms of credit rating) and the lender (in terms of default on loans leading to not getting its money back and loss of collateral).

 

 

References:

Brauneis, M., & Stachowicz, S. (2007). Subprime mortgage lending: New and evolving risks, regulatory requirements. Bank Accounting & Finance (08943958), 20(6), 28-34. Retrieved from: http://eds.a.ebscohost.com.proxy1.ncu.edu/eds/pdfviewer/pdfviewer?sid=ddb0ce68-97ce-42fb-a960-df285b1e27e3%40sessionmgr4009&vid=1&hid=4111

Gilbert, J. (2011). Moral duties in business and their societal impacts: The case of the subprime lending mess. Business & Society Review (00453609), 116(1), 87-107. doi:10.1111/j.1467-8594.2011.00378.x. Retrieved from: http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=59161773&site=ehost-live

Watkins, J. P. (2011). Banking ethics and the Goldman Rule. Journal Of Economic Issues (M.E.Sharpe Inc.), 45(2), 363-372. doi:10.2753/JEI0021-3624450213. Retrieved from: http://proxy1.ncu.edu/login?url=http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=60808385&site=ehost-live

Jarvis, J. (2011). The crisis of credit visualized – HD. Crisisofcredit.com. Retrieved from: https://youtu.be/bx_LWm6_6tA

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