Subprime Special
The term "subprime" refers to the credit status of the borrower, which is being less than ideal. Subprime lending is a general term that refers to the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history.

According to the U.S. Department of Treasury guidelines issued in 2001, "Subprime borrowers typically have weakened credit histories that include payment delinquencies, and possibly more severe problems such as charge-offs, judgments, and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios, or other criteria that may encompass borrowers with incomplete credit histories."

Subprime lending is also called B-Paper, near-prime, or second chance lending. Subprime lending encompasses a variety of credit instruments, including subprime mortgages, subprime car loans, and subprime credit cards, among others. A subprime loan is offered at a rate higher than A-paper loans due to the increased risk.

Subprime lending crisis, which began in the United States has become a financial contagion and has led to a restriction on the availability of credit in world financial markets. Hundreds of thousands of borrowers have been forced to default and several major subprime lenders have filed for bankruptcy.

Types of subprime lending

Subprime mortgages

Subprime mortgage loans are riskier loans in that they are made to borrowers unable to qualify under traditional, more stringent criteria due to a limited or blemished credit history. Subprime borrowers are generally defined as individuals with limited income or having FICO credit scores below 620 on a scale that ranges from 300 to 850. Subprime mortgage loans have a much higher rate of default than prime mortgage loans and are priced based on the risk assumed by the lender.

Although most home loans do not fall into this category, subprime mortgages proliferated in the early part of the 21st Century. About 21 percent of all mortgage originations from 2004 through 2006 were subprime, up from 9 percent from 1996 through 2004, says John Lonski, chief economist for Moody's Investors Service. Subprime mortgages totaled $600 billion in 2006, accounting for about one-fifth of the U.S. home loan market.

There are many different kinds of subprime mortgages, including: interest-only mortgages, which allow borrowers to pay only interest for a period of time (typically 5-10 years); “pick a payment” loans, for which borrowers choose their monthly payment (full payment, interest only, or a minimum payment which may be lower than the payment required to reduce the balance of the loan);

and initial fixed rate mortgages that quickly convert to variable rates.

This last class of mortgages has grown particularly popular among subprime lenders since the 1990s. Common lending vehicles within this group include the "2-28 loan", which offers a low initial interest rate that stays fixed for two years after which the loan resets to a higher adjustable rate for the remaining life of the loan, in this case 28 years. The new interest rate is typically set at some margin over an index, for example, 5% over a 12-month LIBOR. Variations on the "2-28" loan concept include the "3-27" and the "5-25".

Subprime Special (Contd)
Subprime credit cards

Beginning in the 1990s, credit card companies in the United States began offering subprime credit cards to borrowers with low credit scores and a history of defaults or bankruptcy. These cards often begin with low credit limits and usually carry extremely high fees and interest rates as high as 30% or more. In 2002, as economic growth in the United States slowed, the default rates for subprime credit card holders increased dramatically, and many subprime credit card issuers were forced to scale back or cease operations.

Recently, starting in 2007, many new subprime credit cards have begun to emerge in the market. As more vendors have emerged the market has become more competitive and issuers have been forced to make the cards more attractive to consumers. Interest rates on subprime cards now start at 9.9% but in some cases still range up to 24% APR.

U.S. subprime mortgage crisis

Beginning in late 2006, the U.S. subprime mortgage industry entered what many observers now refer to as a meltdown. A steep rise in the rate of subprime mortgage foreclosures has caused many subprime mortgage lenders to fail or file for bankruptcy.The failure of these companies has caused stock prices in the $6.5 trillion mortgage bundled securities market to collapse, threatening impacts on the U.S. housing market and economy as a whole. The crisis is ongoing and is now receiving considerable attention.

One of the reasons for the meltdown is the falling home prices since 2005 in US. As housing prices rose from 2000 to 2005, borrowers having difficulty meeting their payments were still building equity, thus making it easier for them to refinance or sell their homes. But as home prices have weakened in many parts of the country, these strategies have become less available to subprime borrowers.

Several industry experts have suggested that the crisis may soon worsen. Lou Ranieri, formerly of Salomon Brothers, considered the inventor of the mortgage-backed securities market in the 1970s, warned of the future impact of mortgage defaults: "This is the leading edge of the storm. … If you think this is bad, imagine what it's going to be like in the middle of the crisis."

Some economists, including former Federal Reserve Board chairman Alan Greenspan, have expressed concerns that the subprime mortgage crisis will affect the housing industry and even the entire U.S. economy. In such a scenario, anticipated defaults on subprime mortgages and tighter lending standards could combine to drive down home values.

Concerns about the subprime mortgage lending industry is causing a sharp drop in stocks across the Nasdaq and Dow-Jones, which has in turn affected almost all the stock markets worldwide. Record lows are being observed in stock market prices across the Asian and European continents. NSE & BSE has also been affected by it.