A subprime loan means lending an amount below the 'prime' rate of interest to people with low credit ratings. Thus, it is given to people with an imperfect credit profile or the ones that are likely to be defaulters. This makes the recovery of a subprime loan very risky for the financial institutions who lend these kinds of loans. This lending come in two forms: credit cards and mortgages.
This type of lending system evolved during 1993, when the financial institutions realized that there was a high demand for loans despite low creditworthiness. In a frenzied urge to earn more, the banks began lending below the prime rate even though many borrowers qualified for prime loan bracket. Today around 25% of the population of America falls under the category of subprime loan borrowers. The purpose of borrowing such loans is property purchases, cars purchases, remodeling homes, meeting living expenses or even repaying the high interest on credit cards.
A recent study indicated that HSBC, AIG and Citigroup are among the top 25 originators of this lending trend. The banks sold loans on mortgages which proved to be an extremely profitable business, encouraging them to sell more. Due to negligible lending rate, the borrowers surged exponentially. Low rates of interest and high property prices led to the growth of subprime market.
In the successive years, this market has made radical effects on the global economy. The impact was first felt in US, when the tremors of subprime crisis jolted the inner-city areas. By this time the wave of repossession was sweeping across the continent. As a result, the housing sector experienced a national decline on a massive scale.
Today, the builders have been forced to reduce their prices to do away with the unsold property. This in turn, has affected the construction industry, making the big construction players suffer losses and the small ones already calling in a closure.
The downturn in the economy has also affected the luxury goods market, home appliances market and most importantly the automobile market. The historic economic turmoil has seen a loss of roughly one million jobs.
The banks are now cutting down on their credit availability and are clearly refusing applications for credit cards, mortgages, and loan for property purchases. The value of subprime mortgage loans is estimated to be at USD1 trillion.
The financial institutions are now adopting the policy of foreclosure to deal with the mayhem of such lendings. This has resulted in clusters of vacant neighborhoods and sharp drops in property values. The homeowners are faced with high-priced mortgages and low property values. The global investors fear that subprime loan crises may be rooted deeper than it actually looks.
A huge chunk of subprime market is expected to regain its shape through foreclosures. This will have an adverse effect on neighborhoods, exposing it to crime, robbery, and theft. The efforts taken for the betterment of neighborhood in the US are feared to be lost in this colossal chaos. While the government will try fixing the problem of subprime loans, the cities will have to deal with the horrors of devastated homes.