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Date Created: 12/20/15
Subprime Mortgages And Second Mortgages The subprime mortgage industry has been a common topic of current events over the past 4 years. Yet the average home owner with mortgages didn't understand the financial contracts to which they signed on. There are many lessons to be learned. In order to comprehend one must understand the economics of banking and finance. So how did the subprime lending industry get its start? As mortgage rates dropped and home buying became wildly popular, many potential homeowners sought financing but were turned away from traditional banks and mortgage lenders. The practice was justified because it allowed borrowers with an imperfect credit history to receive home loan financing. First, with rising property values, the borrowers were able to gain equity despite paying less than the fully amortized payment or interest- only payments each month because of perceived appreciation. The most common type of subprime mortgages was adjustable-rate mortgage (ARM) A mortgage whose interest rate changes periodically based on the changes in a specified index. At the beginning the interest rate was low but the promissory note stated that the interest rates were not fixed but fluid. In other words, they were adjustable. Also included in the promissory note was the schedule when the rate would adjust or rise. This is known as the adjustment date The date on which the interest rate changes for an adjustable-rate mortgage (ARM). In the 1980s, state usury rate ceilings were lifted, creating a whole new market for people who previously couldn't qualify. At higher interest rates, fees, and other add-ons they did. Most borrowers got so-called "2/28" and "3/27" hybrid adjustable rate mortgages (ARMs). They originated with low fixed "teaser" rates, good for a two-year period. Afterwards, they're reset semi-annually based on an interest-rate benchmark, or the current going rate. For many holders, payments soared 30% and became unaffordable, and by 2004, 90% of subprime loans were these type ARMs. It was well-known in the industry that "these borrowers (are) most likely to default or become delinquent (and) face foreclosure." The idea was to cash in and let holders take the pain. Ameriquest was a textbook example of this. They provided what they called the 227 and 327 loans, which were a fixed rate for two years or three years and then for the rest of the loan. And once they adjusted, some borrowers understood they were getting an adjustable rate, but they were told that the rates could go down. Second Mortgage Corresponding to the subprime market was the Second Mortgage market. This catered to those with higher incomes and good credit. They already were in debt to their first mortgage. Most consumer debt today is the result of falling into arrears with their payments to the interest rates of having two mortgages. What exactly is a Second Mortgage? Second Mortgage is a loan taken out against your home after you have already taken out a first or primary loan. The equity you have in your home is used as collateral for the second loan. A second mortgage has second priority after the first mortgage. So, if you default on both loans, you need to repay your first loan prior to paying off the outstanding balance on the second. A second home loan allows you to borrow based on your home's equity. The amount of equity you have in your home is the amount of the loan(s) you have paid off, i.e., the amount of the home you own outright. With most lenders, you can take a second loan so that the total loan-to-value ratio of your first and second loan is equal to 85% of the home's appraised value. Interest on a second loan will be higher than with a first loan. This is primarily because if you default, you will be paying off the first loan before the second, and as such there is a higher risk involved in offering second mortgages. calgary
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