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Subprime Mortgage Lending Market
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Road Map What Is Subprime? A Brief History How Does the Subprime Market Work? How Does The Subprime Market Differ From the Prime Market? Why Subprime Mortgages? Subprime Crisis
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What Is Subprime? Prime: Ideal Candidates; Lowest Rate Subprime: Less than Ideal Limited debt experience No possession of assets for Collateral Excessive debt History of late or missed payments Defaulting on Debt Bankruptcy
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History -DIDMCA Depository Institutions Deregulation and Monetary Control Act (DIDMCA) 1980 Deregulated fees and interest rates
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History -AMTPA The Alternative Mortgage Transaction Parity Act (AMTPA) 1982 Variable Interest Rates and Balloon Payments
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History -TRA Tax Reform Act 1986 Increased the demand for mortgage debt Prohibited the deduction of interest on consumer loans Allowed interest deductions on mortgages (This made even high-cost mortgage debt cheaper than consumer debt for many homeowners)
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Subprime Borrower Subprime Lender Proceeds for new loan Investment Bank Mortgage Backed Securities
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Cautions of Subprime Predatory Lending High Rates Hidden costs Adjustable/variable rates Over-value Home Potentially Discriminatory
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Protecting the Lender Not Strictly Predatory High Risk borrowers Transfer/Mitigate Risk Higher Returns
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Subprime Differs From Prime Higher Upfront Costs: Application fees Appraisal fees Higher Continuing Costs: Mortgage Insurance Payments Principle and Interest Payments Late Fees and Fines
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Subprime Market Higher risk –six times as likely to default Subprime ARMs were only 6.8% of USA mortgages in 2007, but accounted for 43% of the foreclosures
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Why Subprime Borrower: They want to Buy Stuff Lender: Higher Returns Able to break into the market 3 rd party: some economists; the government. Homeownership is considered good. Boom In building market
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Subprime Crisis Prime and Subprime mixed 2006 housing bust Adjustable Rate Mortgages -80% Record defaults -underwater Lost investor confidence in ‘safe’ loans
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Questions?
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Sources http://en.wikipedia.org/wiki/Subprime_mo rtgage_crisisInvestopedia ‘The Evolution of the Subprime Mortgage Market’ Federal Reserve Bank of St. Louis Review: Jan/Feb 2006 http://www.washingtonpost.com/wp- dyn/content/graphic/2007/03/14/GR2007 031400174.html http://en.wikipedia.org/wiki/Subprime_len ding
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