Subprime Mortgages and Their Role In The Financial Crisis of 2008

A subprime mortgage is a special type of mortgagein that, it caters for borrowers who possess lower-than-normal credit ratings. As a consequence of the borrowers having thesecredit ratings, there is usually no viability in offering a conventional mortgage. The reason behind this is the possibility that the lender could immerse themselves into a larger-than-average risk of losing to the borrower in defaulting(National Commission on the Causes of the Financial and Economic Crisis in the United States, 2011).Therefore, unlike other mortgages, some steps and provisions are considered. For instance, a subprime mortgage undergoes a higher charge in regard to interest rate. The high interest rate goes as an extra token to compensate for the risk taken by the lender.

Due to the high risks involved, subprime mortgages have seen various negative trends in the past. One of the most renown is the famous financial crisis of 2008. It explicitly happened in 2000 soon after the dotcom bubble burst when the economy was just about to plunge into deep recession.The world’s central banks, in response, tried to stimulate economics(Mian&Sufi, 2014). The first strategy used was the reduction of interest rates. In this way, investors engaged in riskier investments to seek higher returns. Lenders too started taking great risks by offering subprime mortgages. In 2005, the housing bubble hit an all-time high which late collapsed in 2006. The end events of these trends were increased foreclosure activity, hedge funds and lenders declaring bankruptcy(McLean & Joe, 2010).

The subprime mortgage originators (lenders) played the most significant role in this financial crisis by lending people to with poor credit. Since the banks also flooded the market with capital liquidity, lenders had funds at their disposal to lend out to people. The banks therefore, also played a role in initiating the financial crisis.

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