After the Dotcom Crash and September 11 attacks, The Federal reserves lowered the interest rates to create capital liquidity (Liquidity is a financial term that means the amount of capital, or money, that is available for investment). It worked as economy began to stabilise by 2002 by encouraging borrowing, spending and investments. Property prices also started increasing.
House prices followed the general principle of demand and supply - When demand is more than supply price increases. People assumed that property value would always appreciate and wanted to buy more houses as investment. Banks started lending to everybody and also to sub prime customers. Sub primes are people with weak credit history or less of a capacity to repay.
Banks always got higher profits over high mortgage rates associated with sub primes. Financial institutions thought that this is a safe option as even if sub primes start defaulting, they could still sell the property at a much higher price and make a profit. Banks safely repackaged the mortgage products and sold to other financial institution and hence reduced the risks. Investors thinking that the house price will continue to rise decided to put money into the risky portfolio.
The property prices increased to such a level that it was not affordable buyers. New buyers were out priced. Now the supply is more and demand is less and price started falling. As property price started to fall, it became difficult to meet up with the high interest based payments; financial institution stopped investing in mortgage based investment products. Banks in order to compensate the loss increased the mortgage rates, which forced the sub primes to default. The housing bubble burst.
Looking back, the 'Interest only' repayment incentive and very low rate for 1st few years was very attractive. This encouraged borrowers to assume that mortgages were within the affordable limits, believing that they could refinance later when house prices appreciated. When house prices were rising refinancing was available. When house prices started dropping refinancing became difficult, making interest payments unaffordable and increased defaults.
The US housing bubble started to plummet in 2006. It all began in 2001 and reached its peak in 2005. The house sales increased from 2001 due to low interest rates, which reduced cost of borrowing. Mortgages were tempting due to their low introductory prices and minimal down payment. This encouraged borrowers to invest in homes. Dot COM crash in 2000 led to 70% drop in NASDAQ share prices. People pulled out the money from stock market and invested in housing, which seemed like a reliable source of investment.
Mortgage brokers received incentives and higher commissions for selling riskier loans. They made lot of profit, but never did enough to see if the borrowers were able to repay if interest rates increased. Underwriters determine the risk of lending to a particular borrower. Prior to automated process all this was done manually and it took a week to process a loan. The automated process did it in 30 seconds, which made lending to anyone easy. The credit rating agencies gave high ratings to mortgage backed securities.
Sub primes have taken a toll on Stock markets. Financial institutions were forced to do a lot of write-downs. Some homeowners are turning to arson as a way to escape from mortgages. This is having effects on insurance companies. More and more houses are sitting vacant which is attracting squatters and criminals. The declining dollar is also attracting foreign buyers to buy properties as investment. Jobs are being lost. Tenants are being forced out, as landlords cannot afford mortgage payments. What looked like a US crisis’s has spread to the Global economy?
House prices followed the general principle of demand and supply - When demand is more than supply price increases. People assumed that property value would always appreciate and wanted to buy more houses as investment. Banks started lending to everybody and also to sub prime customers. Sub primes are people with weak credit history or less of a capacity to repay.
Banks always got higher profits over high mortgage rates associated with sub primes. Financial institutions thought that this is a safe option as even if sub primes start defaulting, they could still sell the property at a much higher price and make a profit. Banks safely repackaged the mortgage products and sold to other financial institution and hence reduced the risks. Investors thinking that the house price will continue to rise decided to put money into the risky portfolio.
The property prices increased to such a level that it was not affordable buyers. New buyers were out priced. Now the supply is more and demand is less and price started falling. As property price started to fall, it became difficult to meet up with the high interest based payments; financial institution stopped investing in mortgage based investment products. Banks in order to compensate the loss increased the mortgage rates, which forced the sub primes to default. The housing bubble burst.
Looking back, the 'Interest only' repayment incentive and very low rate for 1st few years was very attractive. This encouraged borrowers to assume that mortgages were within the affordable limits, believing that they could refinance later when house prices appreciated. When house prices were rising refinancing was available. When house prices started dropping refinancing became difficult, making interest payments unaffordable and increased defaults.
The US housing bubble started to plummet in 2006. It all began in 2001 and reached its peak in 2005. The house sales increased from 2001 due to low interest rates, which reduced cost of borrowing. Mortgages were tempting due to their low introductory prices and minimal down payment. This encouraged borrowers to invest in homes. Dot COM crash in 2000 led to 70% drop in NASDAQ share prices. People pulled out the money from stock market and invested in housing, which seemed like a reliable source of investment.
Mortgage brokers received incentives and higher commissions for selling riskier loans. They made lot of profit, but never did enough to see if the borrowers were able to repay if interest rates increased. Underwriters determine the risk of lending to a particular borrower. Prior to automated process all this was done manually and it took a week to process a loan. The automated process did it in 30 seconds, which made lending to anyone easy. The credit rating agencies gave high ratings to mortgage backed securities.
Sub primes have taken a toll on Stock markets. Financial institutions were forced to do a lot of write-downs. Some homeowners are turning to arson as a way to escape from mortgages. This is having effects on insurance companies. More and more houses are sitting vacant which is attracting squatters and criminals. The declining dollar is also attracting foreign buyers to buy properties as investment. Jobs are being lost. Tenants are being forced out, as landlords cannot afford mortgage payments. What looked like a US crisis’s has spread to the Global economy?
