Mortgage Rates And Subprime Crisis – An Overview
The global subprime crisis had such far-reaching implications that it is impossible to spell out in a few sentences the large-scale affect it caused on the economy of the world. As expected, Canada too did not escape the worldwide wrath. The fallout has been extensive. Today, money borrowers are bombarded with terms such as prime mortgage rate and subprime mortgage rate. What do these expressions mean? A rudimentary understanding of different types of credit is as much essential as getting to know of terms such as Canada prime mortgage rate. First here is some nitty gritty of what prime interest rate is.
Prime Interest Rate
Prime interest rate is the rate of interest charged by banks to creditworthy customers or borrowers. The general trend of this rate was downward. The main factors that influence this rate are availability of funds in the banking system and demand for credit from corporate and individuals. You will find that when one bank increases or decreases the prime lending rate, the other banks follow suit. Mortgage rates are hooked on to prime lending rates. That is why you see banks offering home loans at interest rates in line with prime lending rates to creditworthy borrowers. Even floating interest rates pegged on to prime lending rates; reasons why we see the Canada prime mortgage rate vary.
Subprime loans are types of loans offered to borrowers at an interest rate higher than prime lending rates. This is because the loans are offered to borrowers who do not qualify for prime rate loans. Such borrowers usually are persons with low credit ratings and considered as risks for defaults. It is for these reasons whenever you read Canada prime mortgage rate in an advertisement, check whether the rates specified are prime lending rates or subprime lending rates.
What Is Subprime Crisis All About?
We all know that the subprime mortgage crisis brought down the entire edifice of the global financial structure. What is the sequence of events that brought a whole lot of people on the brink of financial collapse and on the verge of losing their homes? To look for answers, we need to go back in time to just a decade back when the world was brimming with excess capital. At that time just about everybody, particularly the investment managers were looking for low risk investments with a decent return. However, such instruments were difficult to come by. So where did the money ultimately flow into? The answer was simple enough. US mortgage-market attracted investors like bees to honey, thanks mainly to the vehicle called securitization. Here is how the entire stuff worked.
- A borrower gets a mortgage loan from a banker. Borrowers were plentiful and there were no dearth of different instruments floating around in the market. The interest tariff likeCanada prime mortgage rate was good enough. The bank then sells the mortgage to an investment firm on Wall Street. Mortgages swelled. There were many investment firms willing to purchase thousands of such credits or mortgages. These credits represented a steady flow of income and lenders considered them safe during the entire life of the mortgage. Income was bountiful for the investment company, good enough to make them sell stocks generated from the income to the general public. Mortgage backed securities was the perfect answer to the growing demand for assets. Investors, not just in US, but in Canada too simply devoured these securities.
- Sometime in 2003, the demand for mortgage-based securities was so high that just about anyone who qualified for a credit got one. Rates were no issue for the borrowers at all. For a native borrower any Canada prime mortgage rate was attractive enough. The hunger for mortgage-based securities became insatiable. This forced the rules of the game to be changed to make things easier. The guidelines to start with, required stated income and verified assets from the borrower. The borrower did not have to prove his income, but just state it. This kind of a loan program became popular as SIVA (stated income – verified assets) loan and became particularly popular with borrowers who had good credit but could not document convincingly that they could afford a mortgage.
- The growing appetite of investors made the credit guidelines even more lax. The next step from SIVA naturally was NINA. The abbreviation NINA stands for No Income No Assets. All that a borrower needed to show was a good credit score and there was absolutely no requirement to prove or state anything. Why did the banks become lax? The simple reason was that Wall Street lapped up the mortgages.
- Did not the investors assess the risks involved? They did, by looking at the credit ratings given by agencies such as Moody’s, Fitch and Standard and Poor’s. Almost all the well-known agencies accorded mortgage backed securities triple A (AAA) rating. After all defaults were low and foreclosures few.
- The housing market flourished. Getting a home loan was easy. More people wanted to buy houses. In Canada, the only index people assessed was the Canada prime mortgage rate. Housing prices started to hit the roof. People started to purchase a house for investment just the way they bought stocks. Herein were the first signs of turmoil.
- Bad loans started to emerge when borrowers were not able to repay because of high housing cost. When borrowers experienced problems, they just took another loan to repay the previous. The result was people went into more debt to repay old debt.
- Though the housing costs increased, the average household income did not. Despite the glamorous home loan products in the market, borrowers and investors started shying away. Whatever be the Canada prime mortgage rate, the market started showing signs of weakness. The housing bubble burst and the lenders experienced default on the very first mortgage payment itself. More defaults meant more houses in the market. An oversupply and lack of demand triggered the inevitable. The great housing bubble of 2006 -07 burst.
- Wall Street panicked as mortgage companies started to experience overwhelming and devastating consequences. Most of the securities investors had purchased were worth less than half their value.
Nevertheless, there is no need to back off from taking home loans. After all, you need a home. Just ensure you exercise caution and do some homework. Apart from Canada prime mortgage rate, a borrower should know other things.
- Borrower should consider the risks in the event of future defaults.
- Canada prime mortgage rate by itself will not be adequate to assess whether the borrower can make monthly payments. By factoring in Canada prime mortgage rate it will be a good idea to use a mortgage calculator for the purpose.