Essay on How Sub Prime Loans Led To A Global Recession

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Sub prime lending means making loans that are in the riskiest category of consumer loans. It is lending to borrowers with bad credit, limited debt experience, a history of missed payments and recorded bankruptcies. With a subprime loan there’s a higher risk that the lender doesn’t get paid back, and so a higher interest rate is charged due to the greater risk for the lender. Between 1997 and 2006, the price of the typical American house increased by 124%. Many people assumed that this trend of increasing housing prices would persist. In 2000, interest rates were lowered to try and ward off recession and get the economy going. Lowering interest rates means injecting additional money into the economy. Also, in the years leading up to…show more content…
However, as the economy continued to expand, and housing prices continued to increase, these sub prime borrowers weren’t defaulting at a very high rate at all, surprisingly. And so, the banks were earning a lot of money from the higher interest rates that were charged, and weren’t getting any defaults that are supposed to come with sub prime lending. Because of this, everyone wanted to offer sub prime loans. In fact, people became more creative with the type of lending that they would do. For example, Adjustable Rate Mortgages were put together. This is a type of mortgage loan which allows the borrower to pay a lower interest rate for a set period of time, usually two years, and then once that fixed period is over the interest rate, therefore the mortgage payment, is increased. And because the economy was expanding so rapidly and housing prices were increasing many of the sub prime borrowers took out loans that they couldn’t afford. They could do this since brokers became more lenient. Brokers wouldn’t care whether or not the borrowers would pay back as it wouldn’t be their responsibility once the assets were sold to investors. In addition, people lied about their income and credit histories. They weren’t sure that they would be able to pay off loans after the two year period of low interest rates expired and the higher interest rate kicked in. They did this thinking that by the time they had to repay with the higher interest and bigger payment; they
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