Understanding the financial crisis: The role of subprime mortgages

Julie Brownlee, Fsp Invest, 25 Nov. 2015

Tags: subprime mortgages, what are subprime mortgages, financial crisis, subprime mortgages and financial crisis, risky loans



Few can forget the carnage on the world’s financial markets in 2008 when the financial crisis hit.

Stock markets across the world plunged and governments in the world’s biggest economies spent billions bailing out their banks to prevent many institutions going under.

Much of the blame fell on subprime mortgages.

So what are subprime mortgages? And why did they help lead to the financial crisis?

Let’s take a closer look…



What are subprime mortgages?


Subprime mortgages are mortgages (or bonds) a bank gives to a borrower who has a low credit rating.

Because the borrower has a low credit rating, the interest rates on these loans are higher than a ‘normal’ mortgage. This is to cover the lender for the higher risk of default.


Subprime mortgages and the financial crisis


Subprime mortgages played a key role in the financial crisis back in 2008.

Banks (or lenders) had found a way to make good returns out of risky loans. What lenders did was bundle these subprime mortgage loans together and then slice them up according to their level of creditworthiness.

Credit ratings agencies then gave these bundled loans credit ratings. Ratings agencies gave the lowest risk ones an AAA rating. In spite of the risk, the thinking was that the properties which the loans were secured on would never fall in value right across the US. After all it had never happened before.

These bundles of subprime mortgages were very popular amongst investors. When house prices fell in the US, there was a growing number of defaults on these subprime loans.

This led to a lot of the financial mess of banks and other lenders, who either went under or were bailed out by their respective government.

So there you have it. The role of subprime mortgages in the financial crisis.

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