Subprime Lending

Subprime Lending

Introduction

This paper intends to explore the issues that are created by subprime lending. The problems that arise from subprime lending may adversely affect lenders, borrowers, investors and the economy as a whole. A subprime loan is a form credit financial market that is characterized by a level of default risk than the average for other loans. This type of loan is granted to individuals or business.

Discussion

The prime lending rate is the rate of interest paid to borrowers deemed most reliable for the lender benefit is minimal risk but the disadvantage is low efficiency. A credit is granted to subprime borrowers that are less reliable compensation requires a higher rate, the lender for the risk is higher but the performance more interesting and finally, more risky, but even better performance, there is the junk category (literally "rotten"). For a subprime credit remains attractive for the borrower, sophisticated fixtures with variable rates and complex financial products could help keep rates low at the beginning of the loan.

For creditors, subprime loans were considered risky individually but overall safe and profitable. This perception was based on a rapid and continuous increase in the price of the property. If a borrower cannot pay the resale of the property allow the lender to recover his due.

Subprime loans were mainly developed in the United States and the United Kingdom. In 2006, they represented the United States 23% of total loans underwritten. In 2007, nearly three million U.S. homes were in a situation of default.

Subprime loan has the following characteristics:

Most subprime loans are basically a mortgage. Financial institutions have a ceiling set by the FED of subprime loans, although this limit can be overcome by other intermediary who can purchase with a credit transfer of rights to payment of subprime loans by banks to third, in exchange for paying the bank a lower interest rate.

The interest rate of a subprime loan is higher than average interest rates for loans of the same features aimed at user's solvents, varying between 1.5 and 7 points.

The lending system in the United States is based on the establishment of a special assessment rate or the company requesting the loan, so that those who exceed 850 points in the evaluation obtained prime loans to an interest rate low and yield broad benefits. Those with between 650 and 850 evaluation points are considered creditworthy and interest rates that are applied to the credit operations are within the national average. Those with a score below 650 are considered high risk, and are those that can receive subprime loans with higher interest rates and bank charges expenses.

Problems generated by Subprime Lending

Problems that can generate the default of subprime loans in the local economy and the global economy is determined by three factors (Mayer, C. et.al, 2008);

The total volume of subprime representing the total granted.

The number of credits assigned to third parties in transactions of transfer of credits and companies owning them. When are the banks that bear most of the burden of subprime ...