Sub-prime

Introduction

Sub-prime lending is the name given to the practice of lending money to people who cannot afford to pay it back. Typically, these people have a poor credit rating and thus are high risk. The interest rates on sub-prime mortgages tend to be higher than those offerred to lower risk borrowers. However, sub-prime mortgages often have an intial low teaser rate which causes people to think that they can afford the repayments.

U.S. Sub-prime Lending

Sub-prime lending losses in the U.S. caused the Credit Crunch. The amount of money lent to U.S sub-prime borrowers was reported to be approximatly $600bn or about 20% of the total U.S. mortgage market. As inflation increased, the US Federal Reserve increased interest rates to try and keep inflation in check and the number of sub-prime repossesions increased to around 8%. This was not thought to be a problem as the $600bn sub-prime loans only represented a small amount of U.S GDP however, the bankers via elaborate mechanisms had geared the original debt by a staggering ratio of 100:1. This debt was then sold around the world to institutions, such as pension funds, that wanted a low risk but high yield investment. The problem was that many of these were really high risk but credit rating agencies had awarded them a low risk rating.

U.K. Sub-prime Lending

At first there was denial that the U.K. had a sub-prime lending market however, recent evidence proves that there is such a market and that it may be significant. Sub-prime lending is thought to account for about 8% of the U.K. mortgage market. A recent investigation by the FSA found that many sub-prime lendors failed to check that the borrower could afford the repayments (some were on benefits). Many sub-prime mortgages seem to have been sold door to door to people who were renting there council houses and as such they thought it better to pay a mortgage than rent. This ignores the risk that interest rates may increase (as they are now doing due to the Credit Crunch. This type of selling may lead to claims against the lendor for miss-selling.

What does this mean for U.K. house prices?

The U.S. sub-prime lending losses have already caused U.K. mortgage interest rates to rise. In addition, the lack of liquidity has caused a tightening in lending requirements. Both of these will put pressure on existing home owners and first time buyers.

See also