What does Subprime means? and how does it affect to the Stock prices and inflation of USA?

Question

I keep hearing recently about SUBPRIME or SUBPRIME LENDING. What are they?
And how does that affect the Stock Market in the US (which latter affect the world)...

Can someone give me a clear and straightfoward answer?

Thank you ^_^

Answer 1

Sub prime loans and lending are scheduled for folks with less than desirable credit history and are considered higher risk. IE: All those credit card invitations you receive in the mail are Sub Prime with very high interest rates.

When loans go into default, meaning houses are repossed. They become the property of the lender. The lender then has a liability on the books. This in turn has an adverse effect on stocks.

Answer 2

A subprime mortgage can fall under 2 catagories, but usually it is any loan made on a house with less than a 20% down payment (or a traditional mortgage) or a mortgage made to someone with bad credit. The morgages can take many forms as well. People with better credit can still get a traditional mortgage, but must pay PMI until they have 20% equitiy on the home or they take a home equity loan on the other portion of the mortgage so they essentially have 2 loans on the property.

People with less desirable credit have been offered other types of loans. These include Jumbo Loans (over the 417K or so that the Federal Government protects certain loans), ARMs, and Interest Only Loans. ARMs have a fixed finance charge for a period of time, but then once that grace period ends (time of that period can vary.) Interest only loans mean you build no equity for a period on time. Even worse are negative amortization loans. You do not make payments to even meet the interest for a period of time (negative equity) so your principle increases, then you must start making principle payments.

Many of these gimick loans for people with bad credit, or people who wanted to buy homes they could not really afford were popular a few years ago. The time frame for the lower payments (which ever form) has ended and many people have found they cannot afford the higher payments. Since people are defaulting on these loans banks are losing money. In order to make up for this, there is an upward pressure on interest rates. This upward pressure means companies etc, have the potential to be less profitable and since a stock price bydefinition "is the present value of future cash flows." Stock prices tend to head down.

Answer 3

I'll do my best.

If you take a look at your credit card statements, if you have any, they will usually say your interest rate is prime + ##%. The prime rate is determined by a number of factors, but usually based on an index. An index is essentially an average of "gains" from a number of stocks, mutual funds, ETFs, etc. The same goes for mortgages, or any other loan, for that matter.

When mortgages are provided at "Subprime" rates, it means lenders are giving away money for less than the prime rate. That means, the borrower pays LESS THAN AVERAGE for the money they are borrowing. Remember, interest is the money you pay to use someone else's money for a specified period of time. The more people who utilize these subprime loans, the more the average goes down. The more the average goes down, the more gains decrease across the board (stocks, mutual funds, ETFs) and thus effect the economy as a whole.

Answer 4

In this case, PRIME means the same as PRIME MEAT. It means "GOOD."

Sub-prime means not so good. During the housing boom, lending companies lent money to anyone and everyone, regardless of they can afford it or not.

Lending companies used to have standards. The customer needed to have sufficient income, stable employment, and good credit, to get loans. They even checked and double checked.

During the last few years, they IGNORED their own rules and lent money not caring if the customer can pay it back or not.

Affected by this, with so much demand and not enough supply, housing price went UP. Loan amount even got bigger, and the rule got even more relaxed.

Now, prices coming down and many homes now are not even worth the price. People can't pay because interest rate started going up.

Now, people are not paying and defaulting. Which means there are more and more people in serious bind.

Because there is less money to go around, the economy is sinking. Stock prices *can* go down, although not directly related, simply because economy is in the down turn.

I made some omissions in my explanations, but this is as simple as I can make it and still be reasonably accurate.