The American Dream — or Not
What the Subprime Mortgage Crisis Means to Americans
By: James R. Nowlin, III, Esq.
Feb. 28, 2008
What was once the fast track to home ownership is now one of the weakest links in America's economy. The subprime mortgage lending meltdown has had a dramatic impact on the economy and will continue to play a major role in domestic and international markets, real estate values, and the ability of many Americans to obtain financing to purchase a home or even qualify for certain credit cards. Still, with all the attention focused on the virtual meltdown of this lending practice, many people are left asking the question, ''What exactly is subprime mortgage lending?''
Subprime mortgage lending, also known as ''second chance lending,'' is the practice of making loans to borrowers who do not qualify for prime interest rates because of their credit history. A weakened credit history may be the result of late payments, bankruptcy, foreclosures, repossessions, charge-offs or overextended credit.
Subprime loans are often an inroad to home ownership for individuals with poor credit history; however, the borrowed funds come with certain disadvantages. Such loans come with a higher interest rate in order to offset the lender's increased risk due to the borrower’s weak credit history.
Another disadvantage is that these loans often are made in the form of adjustable rate mortgages or ''ARMs,'' although not all ARMs are subprime loans. Unlike conventional fixed rate 15-year or 30-year mortgages, ARMs offer initially low interest rates that increase after a period of time, usually 2 to 5 years, depending on the terms of the loan. Once the interest rate is no longer fixed, it becomes variable, usually resetting once a year for the remaining life of the loan. Variable interest rates are tied to federal interest rates, which are adjusted by the U.S. Federal Reserve Bank. As federal rates increase or decrease, homeowners' variable mortgage interest rates also increase or decrease.
Although subprime ARMs represent only 6.8% of the outstanding mortgages in the United States, they account for 43% of home foreclosures. As variable interest rates adjust, many borrowers are caught by surprise, having previously expected their monthly home mortgage payments to remain static or within an affordable range. After a rate increase, borrowers who are unable to make their monthly payments face foreclosure and loss of home equity.
When real estate markets are strong and homes are appreciating in value, borrowers can repair their credit by making timely payments and can use their equity to refinance to a better interest rate or fixed interest loan. However, in today's real estate market of deflating home prices, borrowers are finding it increasingly difficult to refinance their homes due to lack of equity.
Many market analysts, economists, and politicians cast wide blame for the cause of the subprime mortgage crisis. One common criticism is that lending institutions and mortgage brokers in the $1.3 trillion subprime mortgage industry were too focused on making a quick profit rather than on properly assessing whether borrowers were qualified to repay the loans. In some cases, lenders or mortgage brokers reportedly ''steered'' borrowers to subprime loans even though those borrowers would have qualified for better, or ''prime,'' mortgages with lower or fixed interest rates.
Other critics blame borrowers for not carefully reviewing the terms of their loans or for taking loans which they knew they could not repay. Still other critics argue that inadequate governmental oversight was the main reason lending institutions were able to capitalize on subprime lending for an extended period of time. These critics assert that the federal government was aware of the lending practices and should have intervened to prevent the current crisis.
Regardless of how blame is apportioned for the subprime mortgage crisis, one thing is clear—countless American families have been deprived of home equity, a fact that will continue to affect the American economy. Loss of home equity makes Americans feel less wealthy, which results in decreased consumer spending. Perhaps most unfortunate of all, however, is that many families facing the brutal consequences of the subprime crisis had envisioned their home ownership as an investment that would help them gain solid financial footing.
Because of these dire circumstances, more than 30 states have enacted laws providing stronger protections for homeowners and stricter requirements for responsible lending. Such measures may give many families a true second chance at holding onto or reaching the American dream of home ownership.
James R. Nowlin is an attorney based in Dallas, Texas, and the founder of Excel Global Legal Search Consultants. He previously practiced in the areas of real estate and financing law.
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