Mortgage Crises
The mortgage crisis was a result of too much borrowing and flawed financial modeling, largely based on the assumption that home prices only go up. Greed and fraud also played important parts.
Let’s start with the greed of the mortgage lenders and investment bankers. In the early 2000s, mortgage rates were low. Low interest allows the borrower to borrow more money with a lower monthly payment. Along with low rates, home prices started to increase. So owning real estate seemed like great investment.
With property value increasing dramatically, homeowners found enormous wealth in their homes. So they refinanced and took second mortgages to get cash out of their homes equity. Some reinvested this money in additional properties. Lenders saw property as good collateral and were willing to provide easy access to money.
Subprime borrowers that should not have qualified for loans got into high-risk mortgages such as option ARMs. An option ARM loan features the flexibility to choose among payment options and an adjustable rate. The flexibility it comes with some risks. The home owner/borrower does not equity unless they make the bigger (amortizing) payments. With the smaller payments, the borrower will owe more on house at the end of the month than at the beginning. So for subprime borrower while smaller monthly payments look attractive, in reality they would be taking on more debt.
In addition, those small payments do not last forever. Sooner or later the bank will want to put the borrower back on track to pay the loan off. When this occurs, the banks set the loan to fully amortize over its remaining life, and the low monthly payments can increase sharply. So for subprime borrowers they often could not afford the recast monthly payments.
Prior to the financial crisis borrowers qualified for mortgages with little or no documentation. Mortgage brokers often committed fraud to “help”