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How Subprime Mortgages Work


Subprime Mortgage Crisis

Neighbor Works

Not all the news is bad in the world of subprime lending. One nonprofit organization called Neighbor Works America is doing something about it. Through its Center for Foreclosure Solutions, the organization has joined forces with mortgage and insurance companies to reach out to borrowers in need. It trains foreclosure counselors to assist borrowers and inform communities of their options.

Neighbor Works took action after learning that a common problem between subprime lenders and their clients is a lack of communication once the borrower falls into financial straits. Often, the borrower is ashamed or afraid to call his or her lender, even though there are actions that could be taken to prevent foreclosure. Lenders often have trouble locating the people in need of advice.

Neighbor Works received more than 100,000 calls in 2007 on their hotline. To explore your options, you can call the hotline at 888-995-HOPE, or visit their Web site.

The drastic increase in the number of defaults and foreclosures on subprime mortgages beginning in 2006 led to a subprime mortgage crisis. By 2008, the overall losses from subprime mortgages reached about $250 billion [source: Rose]. And, due to the complex repackaging of subprime mortgages into investments, this crisis in the housing market contributed to a financial meltdown in 2008 that contributed to a national economic disaster.

The blame for the subprime mortgage crisis is shared among several factors. Many mortgage brokers steered their clients toward loans they couldn't afford. Previously, when someone wanted a loan, he or she would go directly to the bank. More and more, people were going to mortgage brokers to act as the go-between. The result was an industry that wasn't directly accountable when a loan goes bad. Mortgage brokers didn't suffer any penalty when a loan they drafted defaulted, so there wasn't much incentive to turn down applicants in this commission-based industry.

The unemployment rate was also a factor leading to the crisis. Midwestern states hit hard by auto industry layoffs ranked among the highest in foreclosures [source: Federal Reserve]. Many people had been counting on being able to refinance to make their loan affordable, but slowing appreciation rates in the housing market made it difficult or impossible. Once the introductory period on the subprime loans ran out, the new payments were more than many could handle.

The borrowers also must bear some responsibility. In a time when credit was easily attainable, many didn't read the fine print of their loan terms or simply took too big of a risk on a loan that they couldn't afford to pay back. It's also common for someone looking to get into the housing market to overstate his or her income to secure a loan.

Another ugly facet of the subprime crisis is the assertion that many lenders exploited minorities in the rush to get rich. The Home Mortgage Disclosure Act (HMDA) of 1975 made it mandatory for lenders to maintain and disclose data in relation to their loans. In recent years HMDA numbers vary wildly across racial lines. Black and Hispanic borrowers are more likely to have a subprime loan than Caucasians. In fact, in 2006, there was a difference of 36 percent, with 53 percent of blacks having subprime mortgages compared to only 17 percent for whites [source: Federal Reserve]. In addition, a 2006 study by the Center for Responsible Lending (CRL) found that when credit risk was equal, blacks were still 31 percent to 34 percent more likely to receive a higher rate than whites [source: CRL]. Since 2007, the NAACP has filed more than a dozen lawsuits against leading subprime lenders for practicing "systematic, institutionalized racism in making home mortgage loans" [source: CNSNews.com].

To understand how the subprime mortgage crisis led to the worst U.S. recession since the Great Depression, read How can mortgage-backed securities bring down the U.S. economy? For more information on mortgages and the financial system, please explore the links on the following page.