DEFINITION OF SUBPRIME LOANS AND HOW THESE LOANS CREATE THE CRISIS
The subprime mortgage crisis was a situation that led to the economic global crisis, which then also led to the recession that began in 2008. Subprime loans are type of loans that are granted to borrowers whose their credit history is not sufficient to get a conventional mortgage which means these loans are offered to people who may have difficulty in maintaining the repayment schedule of conventional loan. These loans offer interest-only loans where the borrowers only need to pay interest for each month and they does not require to make any payment of the principle for the first several years of the loan. This makes subprime loans cheaper than a conventional loan. The U.S. housing market was oversupplied and since that the monthly payments of these loans are lower, it allowed the borrowers to afford a larger home by borrowing money at cheap rates. The subprime borrowers are often turned away from traditional lenders because traditional lenders offer lower credit ratings or there might have other factors that suggest that they may fail on the debt repayment.
The first cause of subprime mortgage crisis was housing bubble. During the housing bubble, most borrowers took on subprime loans because the value of houses increased and they assumed they could refinance the lower payment. They believed that they would sell the home before the interest rate increased. Unfortunately, the bubble housing began to explode in 2005 and the price of the houses started to decrease. Due to this situation, the refinancing become more expensive because of adjustable-rate mortgage was reset at higher mortgage rates. Therefore, when the interest rate started to rise and housing price started to drop, the borrowers were unable to refinance. When they could not afford the increased payment, they are defaulted on the mortgage