Subprime Mortgage Crisis

The current mortgage crisis has brought to light subprime mortgage lending. A subprime mortgage is a loan granted to borrowers with poor credit ratings who cannot qualify for a conventional mortgage. Because of the increased risk to the lender in this type of loan, the lender charges an interest rate above the prime lending rate. The prime lending rate is the interest rate that lenders charge to their most creditworthy customers.

Adjustable-Rate Mortgage

The most common type of subprime mortgage is one with an adjustable rate. An adjustable-rate mortgage (ARM) is a mortgage that initially charges a low, fixed interest rate but then becomes adjustable after a certain period of time. After that initial period, the interest rate fluctuates based on an index.

This type of mortgage is attractive to subprime borrowers because of the initial low interest rate. Many of these borrowers are unaware, however, of just how much the interest rate can increase. When the interest rate increases, monthly payments increase. Significant increases in the interest rate have driven many subprime borrowers into foreclosure. In fact, although foreclosures are up all over the country, 43 percent of foreclosures are on homes bought with subprime mortgages. That is a high number considering the fact that adjustable-rate subprime mortgages make up only 6.8 percent of the market.

Predatory Lending

While some subprime mortgage loans result from fair dealing, many come from dishonest lending practices, also known as predatory lending practices. A predatory lending practice is any action by a lender that misrepresents the terms of the mortgage contract to the borrower. It also encompasses deceptive methods used by lenders to convince borrowers to agree to unfair terms in a loan.

Most states have enacted laws to further regulate the mortgage-lending industry. Many of these laws also aim to crack down on unscrupulous lending. For instance, Texas now has a Residential Mortgage Fraud Task Force, aimed at working with local, state and federal officials to protect potential home buyers. California, a state whose foreclosure rate is twice the national average, recently added to its predatory lending laws a law that targets lenders who pressure appraisers to appraise a property for a certain amount, thus artificially inflating the price of the property.

New York’s new mortgage law is one of the most stringent in the country, expanding upon the predatory lending law but also placing new restrictions and requirements on lenders from the initial loan through default and foreclosure. Other states, such as Florida and Illinois, have addressed the mortgage crisis by passing laws that further protect home buyers and punish unscrupulous lenders.

The best tip for finding a reputable lender is to research and take advantage of available resources. Call the Better Business Bureau to research complaints against a particular lender. Ask friends or relatives who own homes about their experiences with their lenders. A state office (usually the attorney general’s office) will have information about buying a home. If you can, hire an attorney when buying a home; he or she will have experience dealing with lenders and will look out for your interests.

Last update: Oct. 29, 2008