How the Subprime Market Collapse Impacts You

Upon hearing of the growing rift in subprime lending, responsible borrowers might be inclined to think, "Ah…over-zealous homebuyer…you've gotten yourself in too deep.  Too bad for you."  Unfortunately, the ill effects of the subprime implosion may stretch their ugly arms into the backyards of the financially prudent, too.

To put things in perspective, remember what happened when aggressive lending was at its peak. Looser underwriting guidelines dramatically increased the total number of potential homebuyers. The demand for homes soared, prices rose, residential developers started building, and the housing trades got busy. Industry gurus have released some pretty impressive numbers quantifying this increased activity: According to Inside B&C Lending, the subprime lending sector drove $640 billion into the economy in 2006.

Slip sliding away
Now, turn that logic backwards. When subprime borrowers started sliding into default, lenders' losses began to pile up.  The numbers aren't small potatoes—sources estimate that nearly 20 percent of all subprime mortgages made in the last two years will end in foreclosure. Some lenders shut down their subprime operations, others closed their doors completely. The lenders remaining in the subprime sector are being pressured by secondary market investors and the federal government to overhaul their lending practices.  As a result, underwriting guidelines have tightened up again, loan costs have risen, and the pool of potential homeowners has shrunk.

More restrictive guidelines for all
The subprime implosion hits you the hardest if you need credit, or if you need to sell your home. In the aftermath of subprime losses, lenders are looking more closely at prime lending practices, as well. Even if you have great credit, traditional mortgages and equity lines of credit will cost more. And you may not even be able to get an alternative mortgage, no matter what your income profile and credit history look like.

Harder to sell
Selling your home presents a different problem. Simply put, there aren't enough buyers out there who can obtain financing. Those who do qualify for a mortgage will have to pay more for it, which means they'll spend less money on a house. All of this puts downward pressure on housing demand and housing values. And if you have foreclosures in your neighborhood, the value of your home could suffer because of your proximity. 

Declining stocks
In early 2007, several financial institutions made announcements about mounting losses and high default rates. Freddie Mac subsequently announced that it would no longer purchase risky subprime mortgages on the secondary market.  Following that news, the stock prices of many financial institutions took a beating. At the same time, other companies that are heavily dependent on the strength of the housing industry have also been impacted by the downturn. More than likely, the affected stocks—and maybe parts of your portfolio—will continue to be volatile until the housing and lending markets recover.

What's the bottom line?  Just as we benefited from the strength of subprime lending, we'll now have to suffer through its weakness as well.

By Catherine Brock - MortgageLoan.com