Subprime Loans | Meaning, Role in the Great Recession, and Danger

Everyone who lived through the Great Depression was profoundly affected by it. The same is likely to be true of those who lived through the Great Recession in 2008 and the aftermath that followed. The years that have followed have seen all manner of different dissections and analyses of the events leading up to the Recession, how it played out, and what its aftermath was and continues to be.

One prime component in all of that? Subprime mortgages.

What Are These Sub Prime Loans?

There are few things more problematic in the financial world than dealing with loans that are fishy at best and insolvent at worst. This, in a nutshell, is what these subprime lending options are. They are loans that are so high-risk that they are deemed toxic and incredibly unwise. So why did so many banks offer them to customers? They offered them because of the high rates that they could charge for such loans. For as much as we would like to think that our banks are pillars of society, even with the majority of bankers and those involved in the banking industry striving towards that idea, the fact remains that banks are, at the end of the day, a business. To remain afloat, they need to make money, and in order to make money, they need to remain competitive. One way of doing that? Offering loans that other banks would not – namely, to those who would otherwise be denied for said loans due to their poor credit, insolvency, or other risk factors.

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Who Got Sub Prime Loans

This risky lending translated to loans being given to people with no credit history, a poor credit history, and an unstable work situation. People who had missed loan and mortgage payments were getting 100% loans; they didn’t even have to find a deposit for their house, car, or whatever it was they were taking a loan for. Banks were even offering 110% mortgages to professionals without great credit, essentially giving them back 10% of the price of their home as a lend. The market was incredibly fluid.

With a history of not managing their finances well these subprime borrowers were not in a good place to keep up with repayments, and, if interest rates went up, were in serious trouble.

The banks thought that they were doing profitable business and were incentivised to keep going by their need to please shareholders and investors. Down the chain brokers and staff in banks were taking on ever more risky cases to satisfy the appetite for profit. It was a profitable business all around. Wasn’t it?

The situations continued unchecked for years, with an ever more stretched bubble developing, and loan books being sold in the investment market containing a high percentage of toxic loans. In some cases 50% or more of the 100s of loans being sold as an investment were subprime. That was fine until everyone realised that these were not good investments.

What Role Did They Play in the Great Recession?

The problem is the risk factors don’t simply go away. While it’s important for people with bad credit scores to get the second chances that they need and deserve to recover financially, a bad credit mortgage isn’t something to take lightly. As stated above, it’s a high-risk endeavour, with significant chances of defaults and financial losses. Anyone who remembers the Housing Bubble in the mid-2000s knows this all too well, as that’s precisely what happened there. Far too many subprime loans were given to people with poor credit scores, who then defaulted. A few defaults here and there are to be expected, and banks can recover from them. When they are as widespread as they were in 2008, however? It can lead to a domino effect of disastrous proportions, such as that which saw mainstays of the banking world like Lehman Brothers go under.

Many Sub Prime Lenders Disappeared

Subprime lenders and brokers left the market and either refocused on other lending products or folded altogether. There was a long period where it was a lot harder to get loans with adverse credit. The Government put in place measures to improve lending criteria and rebranded the Financial Services Agency to the Financial Conduct Authority, with the new name clearly signalling the need to up the level of professionalism and ethics in the industry.

What Danger Does the Sub Prime Still Pose?

The underlying danger of these kinds of mortgages and loans is all too clear. Given their unstable and often insolvent nature, they can leave both the borrower as well as the lender on the hook for huge financial losses if the loans in question aren’t able to be repaid. Granted, there are many ways to approach these loans and an adverse credit mortgage in general, and there are many different types – such as interest-only, adjustable, and fixed rate loans – but at the end of the day, those risk factors remain the same.

That’s the legacy of these subprime loans – high-risk gambles that eventually came up snake-eyes and left borrowers, banks, and the public at large paying the bill.

The loan market has been changed up. The focus on salary has given way to affordability. Lenders now look at subprime cases in a far more holistic way, trying to understand disposable income and the way that the borrowing will fit into their financial situation. This has certainly made the situation better. However, there is a lot of uncertainty right now and interest rate hikes could still cause a problem. Banks have short memories and risky lending practices have already begun to slip back into the market. New labels are dreamed up for profitable, yet risky lending products, and the world moves on. Whether that will manifest in another problem, especially if there is a fall in house prices, remains to be seen. It does seem that the lending