You can find the origins of the mortgage crisis in the U.S. housing bubble, which reached its peak in 2005. Historically low interest rates combined with new mortgage products that appeared to make home ownership more accessible encouraged record numbers of people to purchase and refinance homes.
Lenders competed for new business by offering attractive incentives, such as low introductory rates, reduced down payments, and interest-only loans. Many borrowers took advantage of these offers assuming that interest rates would remain low and property values would continue to increase, so that they would be able to refinance at favorable terms.
However, some borrowers did not fully understand or were not properly informed of the risks involved — for instance, that the interest rates on ARMs could rise sharply once the loans reset, dramatically increasing monthly payments. Some lenders compounded the risks inherent in these mortgage products with lax underwriting, in which borrowers were approved for loans that they had little chance of being able to repay.
Housing boom…
If historically low interest rates and subprime loans share the blame for the housing bust, they also helped fuel the housing boom, by increasing demand for new and existing properties. According to the S&P/Case-Shiller national home-price index, the prices of homes in the U.S. rose 124% between 1997 and 2006. Aggressive lending to people with weak credit contributed to this growth. During this same period, subprime loans grew from 9% to over 20% of the mortgage market.
Lending and borrowing practices based on an overly optimistic assessment of the housing market also played a role. Because the nationwide housing market hadn’t suffered serious setbacks in the recent past, few anticipated that these trends would change in the future. As home prices rose, many people of all income levels took advantage of the low interest rates to refinance against the rising values of their homes, taking out cash that they used for other purchases. Many didn’t anticipate that their borrowing costs could go up because interest rates might rise, or that their homes might drop in value in the future.
….and bust
However, by 2006, the cost of housing had reached what it’s now easy to see were unsustainable levels. This, coupled with the effects of overbuilding in many parts of the U.S., started to drive home prices downward.
With home prices dropping, some borrowers owed more on their homes than those homes were worth. Unable to refinance due to this negative equity, and with home sales slowing, unprecedented numbers of people began falling behind on their mortgage payments.
Some delinquencies were the result of a rate reset. But the majority were due to borrowers who simply could not afford their loan even at the introductory rate.
Walking away
Today, record numbers of homeowners are making the choice to walk away from their homes — and their mortgage payments. Some families are making that decision out of necessity. Others, overextended by investment properties or second homes, may feel little incentive to pour more money into properties that have lost value and have little chance of rebounding anytime soon.
Borrower and lender fraud
Fraud on the part of lenders or borrowers has also played a major part in the subprime crisis. In some cases, brokers and lenders didn’t disclose the risks of loans or lured borrowers into mortgages they couldn’t afford. Low documentation requirements and in some cases careless underwriting of loans made it possible for borrowers to falsify information on their mortgage applications or get approved for loans without having their income or assets verified. Lack of oversight of mortgage lenders and brokers compounded the problem.
If historically low interest rates and subprime loans share the blame for the housing bust, they also helped fuel the housing boom, by increasing demand for new and existing properties. According to the S&P/Case-Shiller national home-price index, the prices of homes in the U.S. rose 124% between 1997 and 2006. Aggressive lending to people with weak credit contributed to this growth. During this same period, subprime loans grew from 9% to over 20% of the mortgage market.
Lending and borrowing practices based on an overly optimistic assessment of the housing market also played a role. Because the nationwide housing market hadn’t suffered serious setbacks in the recent past, few anticipated that these trends would change in the future. As home prices rose, many people of all income levels took advantage of the low interest rates to refinance against the rising values of their homes, taking out cash that they used for other purchases. Many didn’t anticipate that their borrowing costs could go up because interest rates might rise, or that their homes might drop in value in the future.
However, by 2006, the cost of housing had reached what it’s now easy to see were unsustainable levels. This, coupled with the effects of overbuilding in many parts of the U.S., started to drive home prices downward. 