For plenty of people, the term “subprime mortgage” is a dirty phrase, notes Sam El Barouki, a business professional who is currently studying subprime mortgages and the banks who didn’t offer them. When the subprime mortgage crisis hit in 2007, the precursor of the great recession, the financial damage they caused, not only to banks but also to the thousands of people who lost their homes and financial security, made it seem as though subprime mortgages were gone for good.
Although many financial institutions have learned their lessons and are avoiding subprime loans, recent evidence points to a return of the mortgages, at least on some level. Some potential borrowers simply don’t meet the requirements for a qualified or regular mortgage. The return of subprime loans can give such people space to borrow. But, it will be necessary for banks to approach the lending situation with a lot more caution than they did in years past.
What are Subprime Mortgages?
Quite simply, subprime mortgages are home loans given to people who don’t qualify for a standard mortgage. The home loan might be extended to a person or persons who don’t have the best credit, to people who either have a low income, or to those who are unable to verify the amount of their income.
The subprime mortgage crisis that began in 2007 was in some ways a result of the terrorist attacks that occurred on September 11, 2001. The US economy was already struggling thanks to the boom and subsequent bust of the dotcom era.
The attacks set the economy back even more.
In response, the Federal Reserve slashed interest rates, making the idea of borrowing to purchase a home more appealing. Although interest rates have since dropped even more, in the early years of the 21st century, rates were at an all-time low.
And so, the subprime loan became a popular option. “It felt gratifying, putting people in houses and helping them achieve the American dream,” notes Sam El Barouki.
“At the end of the day, the subprime loan was a sexy commodity,” El Barouki continued, “As soon as one bank started selling them, everyone else followed suit.”
Ultimately, what that meant was that more people were able to buy a house, but that the foundation on which the mortgages stood was incredibly shaky. “I was managing over $20M in lending volume at the time of the collapse, which is quite a lot,” Sam El Barouki said, “As an employee, I stopped to think some of these might be bad loans. The company was very aggressive with handing these loans out, pitching it like it was no other, and I trusted them.”
Things did fall apart for many subprime borrowers and for the mortgage industry in general, around 2007. Many of those loans were made with an adjustable interest rates. With the low post-9/11 rates, the mortgages were affordable. But, once those rates jumped, combined with the crashing economy and the loss of many jobs, people were unable to afford their loans and began defaulting left and right.
Could the Mortgage Crisis Have Been Avoided?
The subprime mortgage crisis could have been avoided, had lenders been more cautious about making the loans. It’s important to note that not every lender made subprime mortgages. “Eighty percent of banks in the United States gave out subprime mortgages,” says El Barouki. He’s currently examining the banks that didn’t make subprime loans, to understand out why the 20% avoided the mortgages.
“A lot of the banks that did not were obviously very conservative and while they did not stand to make as much money as those who were offering these loans, they did, however, correctly analyze that risk and came out better than most in the end,” he says. Had other lenders been a bit more cautious with the loans and had they not had their judgment clouded by greed, the outcome could have been a lot different.
Is There any Value in Subprime Loans?
Although the subprime mortgage industry had a huge role to play in the housing market crisis and the connected recession, it’s not fair to say that all subprime mortgages are necessarily bad or that they should be banished for good.
The American consumer and borrower tends to be much wiser today than back in 2007 or earlier. “I think in response to the collapse Americans have had to increase their financial literacy, and their financial awareness,” notes El Barouki, “We saw in 2009 – 2011, the consumer was much more interested in and aware of what was going on. People were asking much more intelligent questions.”
There can be room in the market for subprime loans, as long as lenders take a more cautious approach, notes the New York Times. Documentation and paperwork are a must in the new era of subprime mortgages. People applying for a subprime loan now need to have concrete evidence of income and undergo a credit check.
The other big difference between subprime loans then and now is the size of the down payment. These days, poorly qualified buyers need to put down 30 percent, according to Bloomberg BusinessWeek.
The new model of subprime mortgages still prevents the grossly unqualified for buying a home. But, Sam El Barouki notes, it allows others who would otherwise be shut out the opportunity to purchase, with reduced risk for the financial institution.
So should subprime mortgages come back, and play a role in today’s loan market? The answer, as it stands now, is a definite maybe.