What is a subprime mortgage?

The subprime mortgage market: What you should know, why you should care

The subprime mortgage market is made up of companies that loan money to homebuyers who would not otherwise qualify for conventional mortgages because of a subpar credit report or lack of cash for a down payment—or both. Often times lenders initially charge a lower interest rate. However, the original mortgage rate typically adjusts significantly higher after several years.

During the recent housing boom, subprime mortgages increased as a percentage of the mortgage market as rising home prices, low mortgage rates and a strong economy made it attractive for lenders to take on high-risk borrowers.

What happened to create a crisis in the subprime market?

The positive conditions that supported the market began to unravel as the housing market weakened, interest rates rose and mortgage payments for subprime borrowers reset substantially higher. Mortgage delinquencies and foreclosures have risen sharply and more than two dozen subprime lenders have already failed or filed for bankruptcy due to the rising rate of foreclosures. Now, the crisis has spilled over to other areas of the financial markets, raising investor concern about banks, brokers and hedge funds that invested in subprime loans and have incurred losses. Some mutual funds that invested in subprime vehicles have also been affected. These and other factors have created substantial investor unrest, spurred volatility in both the domestic and international financial markets and led to tighter credit conditions for prospective borrowers.

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