>Also, this is a TERRIBLE example of a pending subprime crisis. A guy borrows $675K on a $1.1 million property.
Well isn't the point that you/they are making that determination on equity alone? As we saw in 2008 all that equity can disappear in a blink of an eye. Equity has no bearing on ability to repay. So before deciding if this is a good or bad loan wouldn't we need to know his outstanding debt to income ratio?
And neither Equity, or ability to repay (debt/income ratio) has anything to do with subprime lending or a subprime lending crisis. Subprime generally means enticing debtors with interest rates below prime, with a loan that will adjust to above prime (and many times even into a single balloon payment at the end which statistically almost no American can make). No one should qualify for such loans on the basis "you may be able to refinance again at the end to avoid the balloon payment", if you don't have the cash on hand to pay the balloon payment, you shouldn't qualify for these types of loans.
> Subprime generally means enticing debtors with interest rates below prime
No, subprime lending refers to riskier loans, usually with commensurately worse terms, offered to people with less-than-prime credit status. It has nothing to do with the prime rate, and I have no idea where you got that idea. I mean, as folk etymology goes it's superficially plausible, but it's one of those things that I think wouldn't survive even the most casual contact with the use of the term in the wild.
>It has nothing to do with the prime rate, and I have no idea where you got that idea.
Everything you say is true, but its also true over 90% of subprime loans were ARMS (adjustable rate mortgages)[1], leading to the subprime mortgage crisis, where the interest rates started off below prime and gradually increased to over prime to compensate for the risk of the borrower.
1. SOME of the equity can disappear in the blink of an eye. The lender has a nice cushion when the buyer puts down 40%. That's hardly considered risky, which is why this is a terrible example.
2. Subprime refers to the class of borrower, typically based on their less-than-ideal credit scores. The term does not mean that the bank is offering a rate below the prime interest rate to "trick" potential borrowers into taking on debt.
>The term does not mean that the bank is offering a rate below the prime interest rate to "trick" potential borrowers into taking on debt.
Its not a trick, just something the Borrower's en mass did not understand. They just understood the initial low payments, anyway as I replied above, leading to the mortgage crisis over 90% of subprime loans were ARMS that started off below prime and gradually increased. I did use the word "generally" because its not all, but I think 90%+ is a good use of generally.
It is safe to say that most people don’t understand algebra.
In theory the banks didn’t put a proper interest rate on the loan, since interest rates are mainly to compensate for the risk of lending to the borrower. Although it doesn’t matter since the banks bundled the mortgages together, sold them to each other, and were bailed out.
>It is safe to say that most people don’t understand algebra.
Yes, but most people are not entering legal agreements that require them to understand algebra. One would think, especially with the most uneducated and highest risk borrowers, it would be necessary to understand the initial payment under ARMs are temporary for 3/5 years (depending on the terms, but 3/5 year were the most common) and thereafter the monthly payments will go up (statistically by 75% - so your $1,000/month mortgage payment will go up to $1,750).
>In theory the banks didn’t put a proper interest rate on the loan
Yes, that was one part of the problem (obviously the most uneducated and riskiest borrowers should not have been eligible for these complex adjustable rate mortgages), why on Earth would the riskiest borrowers have gotten loans with temporary interest rates below prime? These were the most likely borrowers to not understand adjustable rates. Other major issues were of course stated income (no proof of income required) and 100% to even 103% financing (no downpayment, banks will even pay your closing costs).
>Although it doesn’t matter since the banks bundled the mortgages together, sold them to each other, and were bailed out.
That is exactly why it matters, because laws were passed to prevent these kinds of loans, and here we are full circle, and the banks are offering these loans again.
A loan at 95% loan to value is risky because a decline in the home's value for any reason, even just price fluctuations in a normal economic cycle, could put the loan underwater, and the bank would get less than the loan amount in foreclosure. At 61% loan to value (the example above), it would take some sort of catastrophe not covered by the home owner's insurance for the bank to not get the principal back, even if the borrower never makes a mortgage payment. Depending on local laws, the bank might be out some legal and administrative fees.
> And neither Equity, or ability to repay (debt/income ratio) has anything to do with subprime lending or a subprime lending crisis.
No, that is exactly what it means.
> Subprime generally means enticing debtors with interest rates below prime, with a loan that will adjust to above prime (and many times even into a single balloon payment at the end which statistically almost no American can make). No one should qualify for such loans on the basis "you may be able to refinance again at the end to avoid the balloon payment", if you don't have the cash on hand to pay the balloon payment, you shouldn't qualify for these types of loans.
No, those are teasers with a low-fixed rate for 2,3 or 5 year, with the rate resetting to a very high adjustable rate after the teaser period. Teasers technically are 30 year amortizing mortgages, but you are correct in that they should be treated like balloons, because the payment after the reset is higher than the borrower can typically make.
In an environment of rising home prices, it should be easy to refi on similar terms at the end of the teaser period, but if prices are not rising, you can see what happened in 2008.
Well isn't the point that you/they are making that determination on equity alone? As we saw in 2008 all that equity can disappear in a blink of an eye. Equity has no bearing on ability to repay. So before deciding if this is a good or bad loan wouldn't we need to know his outstanding debt to income ratio?
And neither Equity, or ability to repay (debt/income ratio) has anything to do with subprime lending or a subprime lending crisis. Subprime generally means enticing debtors with interest rates below prime, with a loan that will adjust to above prime (and many times even into a single balloon payment at the end which statistically almost no American can make). No one should qualify for such loans on the basis "you may be able to refinance again at the end to avoid the balloon payment", if you don't have the cash on hand to pay the balloon payment, you shouldn't qualify for these types of loans.