Understanding the Sub-Prime Mortgage Market Collapse
The sub-prime mortgage collapse was a dramatic increase in the number of home foreclosures that started in the fall of 2006 and became a financial crisis within one year.
Sub-prime Borrowers
A sub-prime borrower is one who cannot qualify for prime financing terms but can qualify for sub-prime financing terms – typically, more onerous than prime financing terms. The failure to qualify for prime financing is due primarily to low credit scores and possibly a low income. A very low score will disqualify the borrower. A middle-of-the-road score might or might not disqualify the borrower, depending mainly on the down payment, the ratio of total expense (including debt payments) to income, and the ability to document income and assets.
Sub-prime Lenders
A sub-prime lender is one who lends to borrowers who do not qualify for loans from mainstream lenders. Some are independent, but increasingly they are affiliates of mainstream lenders operating under different names.
Sub-prime lenders seldom, if ever, identify themselves as such. The only clear giveaway is their prices, which are uniformly higher than those quoted by mainstream lenders. You definitely want to avoid them if you can qualify for mainstream financing. Sub-prime lenders base their rates and fees on the same factors as prime lenders. For example, rates are higher the lower the credit score and the smaller the down-payment. However, the entire structure of rates and fees is higher at sub-prime lenders to cover the greater risk and higher costs of sub-prime lending.
Good and Bad News
The key to understanding the sub-prime market collapse is that a much higher percentage of sub-prime loans go into default.
The development of the sub-prime market has made mortgages (and home ownership) available to a segment of the population that otherwise would have been shut out of the market. That’s the good news.
The bad news is that many sub-prime borrowers are only barely able to afford the houses they purchase. They are encouraged to purchase these houses through the use of adjustable rate mortgages or other sophisticated mortgages. These loans make the terms appear affordable at first. However, the interest rates often adjust upwards increasing the monthly mortgage payments, sometimes substantially increasing the payment amounts to the point that the borrower can no longer afford the mortgage and defaults on the loan. Even if the rates do not themselves make the payments unbearable, many sub-prime borrowers are already at their limits and risk default if they experience a temporary job loss or an unexpected major expense.
Prior to the sub-prime mortgage market collapse, realtors and mortgage bankers encouraged borrowers to purchase homes that were at the outer limits of their financial resources by arguing that residential real estate prices just keep going up and up, so even if the borrower had to sell, they would still make a profit on the house. The only problem with that argument is that eventually home prices flatten out or drop – as they have done in many parts of the US in recent years.
How do sub-prime loans relate to Morgan Keegan bond funds?
The Morgan Keegan bond funds were made up disproportionately of CMOs (collateralized mortgage obligations) that were heavily concentrated in subprime loans. The sub-prime lending crisis caused these CMOs to lose value for two reasons: First the value of the mortgages that backed the CMOs dropped because so many of the mortgages were foreclosed upon. Second, because of the stigma associated with sub-prime loans, the liquidity of the CMOs dried up. There are now far fewer investors willing to buy them. The loss of liquidity further damaged the values of the CMOs and, indirectly, the bond funds that owned them – like the Morgan Keegan bond funds.
If you would like to learn more about Morgan Keegan bond funds and how sub-prime borrowing may have led to your investment loss, and if you’d like legal help in recovering your financial loss, please call 888-930-9091 or email the securities fraud attorneys at Burke Harvey & Frankowski, LLC today to schedule your free initial consultation.
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