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Subprime Mortgage Crisis Basics

By Malcolm Rivers

Economic phenomena on the large scale are frequently confusing because it is unclear how they affect people on an individual basis. Ultimately, an intellectual understanding of such issues is worthwhile but the only way to keep your family's finances safe and secure, and arguably to avoid being part of the problem, is to understand them on an individual level.There are three major pieces of a functional understanding of the subprime mortgage crisis; what a subprime mortgage is, the crisis and how it affects normal people.

What a Subprime Mortgage Is

A mortgage is a loan given for the purchase of a home. Subprime borrowers are people taking out loans who have histories of difficulty paying their debts. Frequently these difficulties lead to poor credit ratings (a borrower is subprime, by some measures, when their credit score reaches 640 or lower) for subprime borrowers, which is why loaning money to them can be a high risk endeavor for lenders. These borrowers may not, in short, pay the funds back as they have histories of difficulty doing so. In order to protect themselves, in theory, from the possibility of borrowers defaulting on these loans, lenders set terms for the loans which counterbalance the risks involved. Counterbalances included higher interest rates and collateral. These interest rates ultimately make paying back these loans more expensive and difficult, as they usually increase net costs each month. Frequently these loans are given to potential homebuyers who, frankly, can't afford the houses they want, even with financial assistance.

The Crisis

The American, and to a degree the global, economy is interconnected. Much of the economy depended on mortgage companies and banks. If banks give loans to borrowers who can't pay them back and many of them default on their loans, any business done with said banks or mortgage companies is damaged. When agreements between lenders and other businesses were based on these mortgages, and thereby on the premise that borrowers would pay the lenders back, a system developed that was built on a foundation of debt that wouldn't be paid. As such, several of the financial institutions involved were badly damaged and had to be bailed out by the government, placing additional pressure on the economy. A recession developed and many businesses and individuals suffered.

How it Affects Us

The interconnectivity of the economy means that the larger an institution is, the more damage it does to the general economy if it finds itself in decline. The size of the banks, general real estate market, and related industries creates a domino effect economically. The whole economy is squeezed by borrowers defaulting on loans which creates lower profits for other businesses, less money flowing through the economy, layoffs, and a tougher job market for ordinary people.

Keep in mind that all of this is basic theory. This problem is complex and multifaceted and there is no one cause. There are also the competing tendencies to justify business practices based purely on short term profits and to vilify large companies thoughtlessly due to biases. As always, do your own research and find out more about this problem and how it could affect you and your family. Good luck!

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About The Author

In 2005, Malcolm attended Harvard University where he received his Bachelors of Arts...

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