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The failure of subprime lenders has been in the news recently. One odd article said how people are proposing that the government enact laws or policies to prevent mortgage companies from selling loans that the mortgagee can't pay back. What I don't understand is why a mortgage lender would sell someone a mortgage that was likely to be not repaid in the first place. Why would anyone lend someone money if they knew it was not likely to be paid back?

I suspect that the people selling the mortgage aren't the ones shouldering the risk: They sell them off to investors as mortgage-backed securities, and so they see no downside if the mortgage fails. This seems very bad to me, especially if they make a profit on selling the mortgage -- this means that the more mortgages they sell, the more $ they make, even if the loans aren't sound. But it raises questions: Why would the market buy loans without proof they are sound?

2007-03-09 03:45:42 · 6 answers · asked by ? 4 in Business & Finance Renting & Real Estate

I do understand that there is known greater risk involved, and that some will fail and some will not. This is ordinary lending: Any loan is a risk; you just determine your tolerance to risk compared to the possible return. What I understand happened in these cases was that loans were sold to people who quite obviously could not reasonably be expected pay them back. Normally with a loan there is some calculated hope that they will get paid back, but in this case as I understand it, people were clearly in way over their heads from the beginning. Which makes it sound to me like something fishy is going on.

2007-03-09 04:27:42 · update #1

6 answers

The topic is complicated. Any attempted to pas a law to protect consumers typically hurts other consumers.

1. Do we want the lenders deciding if you can can afford the loan or do we want the lender to present the facts and let the borrower decide?

Subprime standards were lowered so more people with credit problems could buy a home. Maybe it would have been better if we stopped such people from buying. To protect them from themselves.

2. A lender who then sells on the loan has to meet specific standards when they sell the loan. If it goes into default early of the loan package is not complete then the loan comes back to the lender.

If the buyers of the loans want better quality they will change what they offer for the better quality loans or they will stop buying the lower quality loans. When the buyers are mostly investment banks I am pretty sure they can figure out if they need to change their standards. They do not need regulations to protect them.

3. Proof that a loan is sound is based on averages. There is little you can do to prove that a specific borrower will not default. People with good credit scores do have problems from a divorce, law suits, etc that can impact if they will default on a loan.

In this case people with poor credit were allowed to buy wtih little documentation and no down payment. These are high risk. At the same time the majority of the loans are not in default. The problem is the models for how many would go into default have been proven wrong in that more are defaulting than was expected. Not all the loans; just more than was expected.

All lenders or investors work from the idea of acceptable losses. If you buy a package of loans you normally are buying a mixed bag and expect some will perform while others will have problems. If you buy a package of loans that have little risk of default normally you are buying a slice of many loans with someone else buying the higher risk element. If there is a default the other buyer gets hit first.

Check out the Wikipedia article for Mortgage Backed Securities. The link is below and I will put it up on my blog.

2007-03-09 04:05:47 · answer #1 · answered by Anonymous · 1 0

The collateral for the mortgage is the house. First, the percentage of a sub-prime loan is higher. Second, when home prices are rising the lender can sell the defaulted home and make money. As long as housing prices grow there is little risk and much profit involved in subprime lending. A list of current APRs based on FICO scores is below.

FICO score APR [?] Monthly payment *
760-850 5.784% $1,757
700-759 6.006% $1,800
660-699 6.290% $1,855
620-659 7.100% $2,016
580-619 8.556% $2,319
500-579 9.449% $2,511
* $300,000.00 loan, nat'l. average

While it seems unlikely a subprime buyer would be taking out such a large loan, in CA. even small, older houses were selling at this price.

2007-03-09 04:21:27 · answer #2 · answered by mindshift 7 · 0 0

In general, they're betting those buyers will pay the mortgage even if they can't pay anything else. Most people will take care of the house before credit cards or other debts. There is also money to be made off the super high interest rates.

2007-03-09 05:25:13 · answer #3 · answered by Anonymous · 0 0

Well, when the real estate market was booming there was no risk. Foreclosure netted a payoff and all the fees and charges associated with one; in situations where it didn't you still had the lender dealing with the deficency balance.

Now that the market is flattening out, not so much profit in forreclosure and more problems for the lenders.

2007-03-09 03:49:39 · answer #4 · answered by wizjp 7 · 0 0

Yes, they are obviously trying to lower their risk.

They are most likely selling those loans at a discount to get buyers, and they buyers know they are taking a risk.

The buyers are betting that either the loan will be paid back, or the collateral is worth more than the loan.

2007-03-09 04:12:49 · answer #5 · answered by Quixotic 3 · 0 0

He had to sell the "possession Society" which dovetailed together with his plan to boost the size of the Republican tent. The regulator over the two Fannie & Freddy warned with regard to the disadvantages of subprime loans yet Bush surpassed over him. Then in 2003 the comparable regulator revealed a checklist which defined the solid possibility of a housing crash if the administration persisted it rather is present day direction. Bush in the present day fired the regulator and altered him a private buddy.

2016-12-18 09:17:01 · answer #6 · answered by mundell 4 · 0 0

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