Sub-Prime Loans

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SAIRAM

SAIRAM (Querist)
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04 September 2007 Could some one explain what exactly are Sub-prime loans and why the same is hurting US economy.

CMA Gul S

CMA Gul S (Expert)
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05 September 2007 A type of loan that is offered at a rate above prime to individuals who do not qualify for prime rate loans.
Subprime loans tend to have a higher interest rate than the prime rate offered on traditional loans. The additional percentage points of interest often translate to tens of thousands of dollars worth of additional interest payments over the life of a longer term loan.

Risk to US Economy

if people started losing jobs, and they're struggling to make due and make these payments, you could see a rapidly escalating foreclosure rate.

You just got a tax bill. You don't really know you have sterling credit, or you don't understand what the costs are, because they focus on the monthly costs

SAIRAM

SAIRAM (Querist)
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05 September 2007 Thank you very much GUL. I came across one more important point.I am sharing the same with you all.Most of the loans are lent for a period of 30 to 40 years.So intial instalments contain large portion of interest.

In 1999 Fed int rate was at 1%, gradually rate was increased till 2002 and again decreased to 1%. After 2002 Fed started increasing the int rate to contain inflation and to avoid recession. Present rate is 5.5%.

Interest rate on loans also increased and in many cases int is more than the instalment (happens if the loan is in its intial periods).This resulted in foreclosure. Since int rate is very low between 1999-04 many opted to purchase a home and are effected at a large.

Investors sell the home when loan went to foreclosure/bankrupcy. This increased supply of homes oustripping demand and putting pressure on land prices.(subprime laons are mainly given for home purchases). In mosty the of the cases investors incurred loss.

Now hedge funds (form large part of investors) became over cautious and stopped investing in subprime securities. Banks exhausted money and could not lent any more.This brought the liquidity pressure and hurting economy at large.

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