Summarize the concept of subprime loans and the risks they pose to the lender and borrower.

Standard


The term subprime loan term refers to lending grounded on the borrower’s low credit qualification based on the lack of or poor credit history.   These loans are granted at a higher rate than other prime loans.  The difference between them is risk versus revenue.   The riskier it is, the higher the income (Piera, 2008, p. 1).   Gilbert (2011) describes the subprime lending a mess consisting of individuals defaulting on loans, banks and other mortgage lenders foreclosing on homes (p. 3).   Gilbert continues to state that it also consisted of borrowers removed from their homes, unkempt neighborhoods and squatters (p. 3).   In 2007, experts thought that the crises would have been contained within only the mortgage issuers but no one suspected that the fallout would have been so severe to threaten the economy to such an extent (Bianco, 2008, p. 3).

Easy credit in addition to the anticipation that the housing prices would continue to climb encouraged the majority of subprime borrowers to acquire Adjustable Rate Mortgages. Consequently, they couldn’t afford these types of loans after initial period passed.  Then housing prices started to fall as a result of the price correction and consequently homeowners who could not refinance started to default (Bianco, 2008, p. 10). The borrowers were at risk of losing their homes and having their credit rating indicate, to lending institutions, a very risky borrower.  Research by White (2009) states there is no question that bad decisions made matters worse for lending institutions. The mistakes explain why certain financial institutions got into more trouble more than others (p. 2).  “The high risk on the mortgages came back to banksbite the mortgageholders” (p. 2).  These were the financial institutions that were owed the monthly payments.  As a result of the great recession, a number of large banks went bankrupt or were or acquired by larger institutions.   Research by Havermann (n.d) says that the casualties were as follows, “the entire investment banking industry, the biggest insurance company”,  the largest mortgage lender, the largest savings and loan, and, 2 of the largest commercial banks” and 2 government institutions (para, 1). Read more about the Great Recession.

References

Bianco, K. (2008). The Subprime Lending Crises: Causes and Effects of the Mortgage Meltdown. Retrieved from http://business.cch.com/images/banner/subprime.pdf

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

Havermann, J. (n.d). The Crises Unfolds. Retrieved from http://www.britannica.com/topic/Financial-Crisis-of-2008-The-1484264

Piera, F. (2008). Financial Institutions’ Responsibility in the Subprime Mortgage Crisis. Retrieved from http://www.ethicalquote.com/docs/SubprimeMortgageCrisis.pdf

White, L. (2009). Housing Finance and the 2008 Financial Crises. Retrieved from http://www.downsizinggovernment.org/hud/housing-finance-2008-financial-crisis

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