- 3 min read
Subprime Loans and the Real Estate Market
The Subprime Loan Fallout is Affecting All Areas of the Real Estate Market
The recent problems with subprime loans will eventually affect all aspects of real estate. The real estate market is supported by all home owners, including those with subprime loans. A massive jolt in one sector (subprimes) affects those in other areas (prime loan holders). The reason the market works this way is that we buy and sell homes among each other. In most cases, people sell one house to upgrade or downsize. In order for someone to upgrade their home, they need to have someone purchase it (i.e. someone lower in the real estate market looking to move up to your current level). Without buyers, sellers aren't selling and they're stuck where they're at.
The Workings Behind Subprime Loans
Basically the current fallout with subprime loans is due to their structure and lending. Subprime loans often come with higher interest rates, added fees, and fluctuating terms. Most subprime loans have a low, introductory interest rate for the first two to five years. Then, after this "introductory period", the rate goes up to the standard prime rate PLUS 5% or more. For, example, if the current prime interest rate is 5.25%, when the introductory rate expires, the fully adjusted mortgage rate will be 10.25% whereas a prime loan would be closer to 5.5%. As you can see, this drastically affects the loan and the mortgage amount. Those who got in at a low interest rate didn't have a enough upfront to get a prime loan - so chances of them affording the increase rates is unlikely.
How this All Came to Be
A few years ago when the real estate market was booming and rates were low, everyone wanted a home and lenders were buzzing with business. However, even with low interest rates, not everyone who wanted a home had a credit score or debt-to-income ratio that allowed for a fixed prime loan. This is where the game of predatory lending comes into play. Predatory lenders are loan lenders that take advantage of those will less-than-perfect credit. Basically lenders convince subprime borrows to get into loans that have hidden added fees, fluctuating interest rates, and other negative aspects. Unfortunately the idea of owning a home can cloud a borrower's judgment and they often get into a loan they don't fully understand until it's too late. "Too late" is now.
It's been about 5 years since the boom began and lenders starting divvying out subprime loans. Hence interest rates are fluctuating drastically and subprime borrowers are defaulting on their loans. It's all finally come to a head and the market is taking a beating.
How the Subprime Loan Fallout Affects Primes
As was mentioned before, the real estate market is affected by all types of borrowers. Since less-than-honest lenders were taking advantage of the real estate boom, a significant number of subprime loans were in the market. Now many of these loans are getting defaulted on, sending these former homeowners into the rental market rather than maintaining their homeowner status and ultimately building up enough equity to buy a second house or upgrade to a new home. Less buyers mean the harder it is to sell a home. The harder it is to sell a home, the less homeowners will get for their property. This ultimately lowers home prices across the board and the entire market is affected.
What can You do About It?
If you have a subprime loan and your interest rate is about to fluctuate, try to refinance into a fixed loan. Even if interest rates you're offered are a bit higher than your pre-adjusted rate, chances are it will still be lower than the rate you'll eventually pay when your adjustable subprime loan jumps.